IRS penalties for estimated taxpayers

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Q. 2017 was the first year that both my wife and I have been retired together. We have estimated what our taxes will be and have paid quarterly tax, and included our last quarter due in February 2018. I’ve heard if we underpaid we will be penalized by the IRS. How does that work? I’ve also heard they forgive the penalty for various reasons. Is inexperience with calculating quarterly taxes one of those reasons?
— Estimated payer

A. We understand that you’re new to this, so we’re going to run through a few items.

The federal tax system is a pay-as-you-go system, which means you must pay income tax as you earn or receive income throughout the tax year, said Gerard Papetti, a certified financial planner and certified public accountant with U.S. Financial Services in Fairfield.

He said paying your taxes can be done through withholding taxes if you are an employee or through estimated taxes if you are self-employed or retired.

Importantly, let’s note the fourth quarter estimated taxes for 2017 was due by Jan. 16, 2018, not February. Quarterly estimated tax payments are due April 15, June 15, September 15 and January 15 of the following year.

If you can correctly estimate your income for 2017, you should pay at least 90 percent of the tax that you will owe on your estimated income, said Altair Gobo, a certified financial planner with U.S. Financial Services in Fairfield.

This may be difficult if you cannot accurately estimate your income for 2017, he said.

Let’s dive in a little deeper.

If you owe less than $1,000, you will avoid an underestimated tax penalty, the advisors said.

Papetti said if you owe more than $1,000 and you are required to pay your taxes through quarterly estimates, in order to avoid an underestimated tax penalty, you need to meet one of the following:

1. Have 90 percent of your current year total tax liability paid in by Jan. 15 of the following year, or:

2. If your Adjusted Gross Income (AGI) is less than $150,000 and you have 100 percent of your prior year’s total tax liability paid in by Jan. 15 of the following year, or

3. If your AGI exceeds $150,000, you have 110 percent of your prior year’s total tax liability paid in by Jan. 15 of the following year.

“Note you can also avoid an estimated tax penalty if you annualized by using the Income Method if your income is earned unevenly throughout the year,” he said. “For example, in the event your tax liability increased because of a taxable event that occurred in one quarter and not evenly throughout the year.”

Papetti said the IRS can waive any underestimated tax penalty if you didn’t make a required payment because of a casualty event, disaster or other unusual circumstance and it would be inequitable to impose the penalty, or you retired (after reaching age 62) or became disabled during the tax year or in the preceding tax year for which you should have made estimated payments, and the underpayment was due to reasonable cause and not willful neglect.

Unfortunately, a lack of experience won’t cause the IRS to waive the penalty.

Papetti said if you do not qualify for one of the exceptions and do not have sufficient taxes paid the estimated tax penalty is calculated as follows: Total tax after credits plus other taxes, including self-employment, additional Medicare tax and/or net investment income tax minus refundable credits.

If less than $1,000 is due, you do not owe a penalty, Papetti said.

If you do not have 90 percent paid in the current year tax, or 100 or 110 percent of prior year’s tax (depending on AGI), then the penalty is 2.66 percent of the underpayment for the year, he said.

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This post was first published in February 2018. presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.