Key Takeaways
- Year-end estimated tax payments are credited to the quarter in which they are made, while federal income tax withholding is generally treated as paid evenly throughout the year.
- Additional federal income tax withholding from wages or retirement distributions may help taxpayers reduce or eliminate estimated tax underpayment penalties.
- Taxpayers should review projected tax liabilities, assess withholding adjustments and consider state tax rules or the annualized income method to address potential shortfalls.
A scenario tax professionals see every fall: a taxpayer suddenly realizes that they have missed an estimated payment or simply have not paid enough. Perhaps they received a larger than usual bonus, sold an investment for significant capital gain or business income is just higher than anticipated. Whatever the reason, they are short on estimated taxes for the year.
Unfortunately, when it comes to estimated tax payments, timing matters.
Federal estimated income tax penalties are calculated separately on a quarterly basis. Individual estimated tax payments are due April 15th, June 15th, September 15th and January 15th. Making a catch-up payment in December or January does not retroactively resolve the underpayment from prior quarters.
In contrast, federal income taxes withheld from wages or even retirement distributions are generally treated as having been paid evenly throughout the year. Under the right set of circumstances, additional withholdings can reduce or eliminate a federal underpayment penalty.
For example, assume a taxpayer needs an additional $12,000 in estimated tax payments for the calendar year. The taxpayer could make a January 15th estimated payment which would be credited to the 4th quarter or the taxpayer could have an additional $12,000 withheld and $3,000 would be credited to each quarter, helping the taxpayer avoid an underpayment penalty. However, this strategy only works if the amount withheld is sufficient to cover the taxpayer’s estimated tax requirement.
Who Can Use This Strategy?
This strategy specifically needs to be done through sources of income with withholdings, i.e., payroll or retirement distributions. If your only source of income is from self-employment, as a sole proprietor, partner or shareholder and you have no sources subject to withholding, it’s not possible to increase withholdings.
As a W-2 employee you can increase your withholdings by simply adjusting your W-4 form with your payroll department. In the case of retirement plan distributions, you can contact your plan administrator for a W-4R or W-4P (whichever is applicable to your type of plan).
Note that for married taxpayers filing jointly, either spouse can increase their withholding, regardless of which spouse’s income caused the shortfall.
Practical Next Steps
Review your projected tax liability and the payments already made. Our professionals are available to assist you in calculating any potential shortfall and then, if appropriate, we can recommend additional withholdings while there are still paychecks remaining this year.
The amount needed depends on each taxpayer’s individual set of facts and circumstances and state estimated tax rules should be separately evaluated. Taxpayers whose income was earned unevenly throughout the year may benefit from the annualized income method.
Contact Us
PKF O’Connor Davies tax professionals are able to assist taxpayers with missed estimated tax payments or any other tax matters. Please reach out to your client service team or:
Julie De Los Angeles, CPA
Director
jdelosangeles@pkfod.com