If you’re among the millions of taxpayers who are required to make quarterly estimated tax payments, today, Jan. 15, is the deadline for fourth quarter 2024 payments. Penalties for underpayment of these taxes have risen significantly in recent years, so it’s important to understand the complicated rules and make your payments on time.
A little background
Employees who receive a W-2 from their employer have to pay most of their income tax through payroll withholding. Those with other taxable income, such as investments or self-employment, must make quarterly estimated payments.
If you don’t pay enough throughout the year, you’ll owe a penalty in the form of an interest charge on your underpayment. The interest rate, which is set quarterly, is based on the short-term Treasury rate plus three points.
Average penalties for underpayment of quarterly estimated taxes are on the rise, largely because the interest rate has increased. In the fourth quarter of 2024, the rate was 8% — up from just 3% in the first quarter of 2022.
The rules of engagement
To avoid underpayment penalties, the rules are somewhat complicated. Employees must pay at least 90 percent of what they’ll owe by the end of a given year. For those with other income, the deadline is when fourth quarter estimated payments are due, which is today for 2024 income.
But “safe harbor” rules come into play as well. Let’s say your 2024 income was higher than in 2023. If you didn’t pay 90% of what you’ll owe for 2024 by the above-mentioned deadlines, but you did pay 100% of what you owed in 2023, you won’t owe a penalty. That’s for filers with adjusted gross income of $150,000 or less. For filers with higher incomes, the requirement is 110% of the previous year’s tax bill.
But you’re not off the hook yet. Adding another layer of complexity, the safe harbor thresholds are per quarter. So, if you had especially high second-quarter income in 2024 but didn’t make good on that until today (the fourth quarter estimated tax deadline), you may be subject to a penalty.
Adding even more complexity is the fact that the IRS treats income as though it’s earned evenly throughout the year. So, if you had a big fourth quarter with a side job and made the right fourth quarter estimated payment, the IRS may believe you should have paid more in the previous quarters.
You can let the IRS know when the income was earned and when the tax was paid with Form 2210 and Schedule AI. Or, if it’s all sounding too complicated, work with an accountant. Just be sure to tell him or her about any significant fluctuations in income subject to quarterly estimated tax payments.
Just one more thing
If you’re still with me, there is one potentially helpful complication in the IRS rules and regs. It pertains to taxes that are withheld from certain income that qualifies for withholding. Just as the IRS considers income to have been earned evenly throughout the year, it considers withholdings to have been made evenly throughout the year.
For example, let’s say you owed $1,000 for side-gig income in the first quarter and forgot to pay. Then let’s say you took an IRA distribution in December. If you had an extra $1,000 withheld from the distribution, that should enable you to avoid a penalty on the first-quarter income.
None of this is meant to serve as accounting advice (or to make your head spin!). Instead, it’s intended to draw your attention to some of the complexities involved in quarterly estimated tax payments and the need to be diligent about making your payments in the right amount and at the right time if they are required of you.
