Estimated Tax Penalty Explained (How to Avoid Penalty)

If you’re self-employed, estimated taxes are a part of your business life. This means you may need to send quarterly estimated taxes four times a year (in April, June, September, and January). Your taxes require a different kind of attention than they did when you were a company employee. Self-employed individuals don’t have taxes withheld from every paycheck and United States works on the principle of “pay as you go”, so if you’re self-employed you have to pay taxes yourself.

If you’ve never understood how quarterly estimated tax payments work, how quarterly estimated tax penalties are calculated or determined, or how to best meet these obligations, here are some tips to help avoid estimated tax penalties.

Avoiding Underpayment Penalties

There are ways to avoid a penalty even if you underpay your obligation. The government knows you can’t predict the future with absolute certainty, especially when you’re self-employed, so they give you some leeway.

Generally, if you owe less than $1,000, you do not have to pay quarterly estimated tax payments and will not see an estimated tax penalty. If you pay at least 90% of your tax obligation or 100% of the tax owed in the prior year (whichever is smaller), then penalty can be avoided. If you are a high-income taxpayer, with an AGI over $150,000, then the 100% is increased to 110%.

The IRS recently announced they will now waive the penalty for underpayment if you at least paid 80% of your 2018 tax liability, further reducing the relief IRS originally announced on Jan.16.  The adjustment was made by the IRS in an effort to help taxpayers who were unable to adjust their withholding and estimated tax payments to reflect changes under the tax reform law.

You may also request a penalty waiver due to one of the following conditions:

• You failed to 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.”

You may also be able to avoid estimated tax penalties if you can use the annualized installment method at tax-time to reflect your fluctuating income. If you’re like most self-employed business owners, you may see slow months and then big boosts in others. However, if you do not receive income evenly throughout the year, the required estimated tax payment for one or more periods may be less than the amount figured using the regular installment method.

The annualized method determines your estimated tax liability as your income accumulates throughout the year instead of dividing your entire year’s estimated tax liability by four as if your income was earned evenly. So, if your income is concentrated, for example, in the fourth quarter of the year you may be able to use the annualized income method. TurboTax Self-Employed guides you through the annualized installment method at tax-time.

How to Make the Correct Estimated Payments

If your business is growing, the simplest way is to take your tax obligation from last year and make four equal payments that total slightly more than that amount. If you are a high-income taxpayer, make that four equal payments that total slightly more than 110%.

Don’t worry about knowing how to figure out your estimated taxes. With QuickBooks Self-Employed you can track business income and expenses that helps calculate your estimated taxes.  At tax-time your information can easily export from QuickBooks Self-Employed to TurboTax Self-employed to make tax filing a breeze.

If you underpay your estimated taxes don’t worry, the difference can be paid when the tax return is filed.

Don’t worry about knowing tax laws or forms.  TurboTax will ask you simple questions about you and give you the tax deductions and credits you’re eligible for. If you still have questions you can connect live via one-way video to our TurboTax Live Self-Employed CPAs and Enrolled Agents with an average 15 years’ experience to get your tax questions answered. TurboTax Live Self-Employed CPAs and Enrolled Agents can search for industry specific tax deductions and credits you didn’t even know you were eligible for and they can also review, sign, and file your taxes.