About the Estimated Tax Penalty
If you are an employee who receives a W-2 from your employer, money is withheld from your paychecks to cover your taxes at the end of the year.
If you have withheld enough, then you will not owe any taxes, and you might even get a refund if you have withheld more than the taxes you owe.
However, if you have not withheld enough, then you will owe taxes when you file your tax returns.
But even if you are withholding from your paychecks, you might still owe taxes at the end of the year. For example, if you have significant investment income like interest, dividends, or capital gains from the sale of stocks. If you are self-employed or have income from rental properties, you might also owe taxes at the end of the year. Or if the withholding on your W-4 form is not enough for your filing status, you still could owe.
What are Estimated Taxes?
If you are making money without withholding, the IRS still wants you to pay taxes throughout the year instead of waiting until the end of the year to pay it all at once. Just as they get money from employees all year ’round, they want money from people making other types of income all year ’round as well. These payments are called estimated taxes.
Estimated taxes are due quarterly, specifically:
- April 15
- June 15
- September 15
- January 15
Yes, I know this is not really quarterly as some payments are due more or less than 3 months apart, but that’s just the way it is.
What is the Estimated Tax Penalty?
If you do not make estimated taxes when you are supposed to, then the IRS (and many states as well) will charge you an estimated tax penalty. Specifically, if you owe more than $1,000 in Federal tax with your tax return, you will owe the Federal estimated tax penalty. If you owe more than $500 in California taxes, you will owe the California estimated tax penalty as well.
Often, this penalty is calculated on your tax return and added to the amount you owe. The calculation is based on the current interest rates, and is currently about 5.3% of the tax you owe.
NOTE: In 2023, most residents of California received an automatic extension until November 15, 2023 to file and pay their 2022 taxes. This extension applied to 2023 estimated taxes as well. This means that the automatic calculation of the Estimated Tax Penalty on the 2023 tax return was too high (because it is based on the first quarterly payment being due April 15). Therefore, if you had an estimated tax penalty on your 2023 return, you will probably get some of it refunded.
If you did not include the Estimated Tax Penalty on your 2023 tax return, then the IRS will send you a bill for this penalty. Some bills this year say that the estimated tax payment was “miscalculated” on the tax return. However, it is the IRS who originally miscalculated the penalty for California residents based on the normal due date of April 15. The notices now have the correct penalty based on the extended due date.
You can check to see if you paid the estimated tax penalty by looking at Line 38 on your Form 1040 tax return. If this line is blank, you did not already pay the penalty. If Line 37 is over $1,000 then the IRS will send you a bill if you owe an estimated tax penalty.*
*Note: Under some circumstances you might not owe a penalty even if you owe over $1,000. For example, if you owed no tax last year, or if you withheld at least as much as you owed the previous year.
How do I avoid the Estimated Tax Penalty?
- If all or most of your income comes from W-2 employment, and you are not withholding enough to cover your taxes, you need to submit a new Form W-4 to your employer to adjust your withholding. Your tax preparer should be able to help you complete your W-4 so that you don’t owe next year.
- If you are self-employed or have significant income without withholding, you should make quarterly estimated payments. Your tax preparer can prepare vouchers for you which you can send in with your check on each due date. You can also make estimated tax payments online at the IRS website. If I prepare and e-file your tax returns, I can also have your payments automatically withdrawn from your bank account on the due dates so you don’t have to remember to do it yourself.
