Have you ever filed your taxes only to find that you do not only owe taxes to the government but are being assessed interest and penalties as well? Taxpayers may incur interest and penalties if they fail to make estimated payments or withhold enough tax to cover their liability for the tax year.
In general, you must pay an amount that is the lower of 90% of your current year tax liability or equal to 100% of the tax due in the prior year (110% if AGI was over $150,000 in the prior year).
The Annualized Method is also available to taxpayers who have fluctuating income throughout the year. If a taxpayer chooses to annualize income, he should complete Form 2210 Underpayment of Estimated Tax for Individuals, Estates, and Trusts. Form 2210 uses the amount of income (or loss) each quarter to calculate the amount that should have been paid. If the tax due for the period exceeds the amount withheld and estimated payments, a penalty is incurred. Most states have underpayment rules similar to federal rules.
If a taxpayer has not paid enough to the government, he should adjust withholding or make additional estimated payments. In addition to W-2 wages, tax can be withheld on investment income, retirement distributions, and social security.
No penalty will be assessed if the taxpayer has less than $1,000 tax due. If the taxpayer had no tax liability in the previous year and was a U.S. citizen, he may also avoid a penalty. Penalties may be waived under certain other circumstances as well. Situations such as casualty, disaster, recently becoming disabled or other “reasonable cause” situations could qualify for a waiver.
In most cases, taxpayers with only W-2’s (wages and bonuses) and nominal investment income will have adequate tax withheld by adjusting exemptions on the Form W-4 submitted to their employer. However, any large bonuses should be considered separately to assess withholding requirements. Taxpayers that own businesses or have complex investment portfolios need to consider tax planning as an important tool to avoid unnecessary surprises at tax time. The taxpayer should consider life events such as marriage, divorce, death of a spouse, the birth of a child, or the purchase of a home as part of their tax planning. In the end, tax planning throughout the year is key.
To learn more about avoiding tax penalties, feel free to contact one of our tax professionals.