Do Estimated Taxes Have to Be Equal?

Estimated taxes ensure individuals pay income tax throughout the year as they earn it. This system applies to income not subject to traditional employer withholding, such as earnings from self-employment, interest, dividends, rental properties, and capital gains.

What Are Estimated Taxes

Estimated taxes are payments made directly to the Internal Revenue Service (IRS) by individuals whose income is not subject to sufficient withholding. This includes self-employed individuals, independent contractors, gig workers, and those with significant income from investments, pensions, or rental properties. The IRS requires taxpayers to pay at least 90% of their tax liability throughout the year to avoid penalties.

These payments are made in four installments throughout the year, aligning with the tax year. For a calendar year taxpayer, the payment due dates are April 15, June 15, September 15 of the current year, and January 15 of the following year. If any of these dates fall on a weekend or holiday, the deadline shifts to the next business day.

Adjusting Payments for Uneven Income

Contrary to a common misconception, estimated tax payments do not have to be equal across all four periods if a taxpayer’s income is not earned evenly throughout the year. The IRS recognizes that income can fluctuate significantly, particularly for seasonal businesses or individuals receiving large, one-time payments. Taxpayers can adjust their payment amounts to reflect their actual income earned in each period.

This flexibility is accommodated through the Annualized Income Method. This method allows taxpayers to estimate their income and deductions for specific periods within the tax year, calculating their tax liability based on income earned up to the end of each payment period. This means if income is higher in one quarter, the estimated payment for that quarter will be larger, and vice versa.

The Annualized Income Method helps prevent overpayment of taxes and ensures payments match actual income flow, improving cash flow management for individuals with variable earnings. This method is particularly beneficial for those with seasonal businesses, significant capital gains later in the year, or large bonuses.

Avoiding Underpayment Penalties

Failing to pay enough estimated tax throughout the year can result in an underpayment penalty assessed by the IRS. This penalty is essentially interest charged on the amount of underpayment for the period it was unpaid. The penalty aims to ensure that taxpayers fulfill their obligation to pay taxes as income is earned, rather than waiting until the annual tax filing deadline.

Taxpayers can avoid an underpayment penalty by meeting certain “safe harbor” rules. One common safe harbor is paying at least 90% of the tax shown on the current year’s return through withholding or estimated payments. Another safe harbor allows taxpayers to avoid penalty if they pay 100% of the tax shown on their prior year’s return, provided the prior year covered a full 12-month period.

For higher-income taxpayers, defined as those with an adjusted gross income (AGI) exceeding $150,000 in the prior year ($75,000 for married individuals filing separately), the prior year safe harbor threshold increases to 110%. IRS Form 2210 is used to determine if a penalty is owed and to calculate the amount. In certain unusual circumstances, such as casualty, disaster, disability, or retirement, the IRS may waive the penalty.