Do quarterly estimated taxes need only to match the previous year’s owed taxes?

Do quarterly estimated taxes need only to match the previous year’s owed taxes?

by Robert J. Grossman, CPA | Feb 03, 2014
askacpaiconI pay estimated taxes each quarter. Am I correct that the total of estimated taxes paid for the four payments need only match 100 percent of the taxes I owed with last year's 1040? That is, even though my AGI may be a lot larger, I still have until April 15, 2014, to pay the additional taxes that may be due with the 2013 1040 filing?

Estimated income tax payment requirements in the United States are guided by Section 6654 of the Internal Revenue Code (IRC) of 1986, as amended. The provision is labeled “Failure by an individual to pay estimated income tax.”  Though the section addresses those instances where an underpayment penalty may be assessed for failing to pay estimated taxes on a timely basis and in the correct amounts, the provisions can be read to interpret different methodologies for avoiding the underpayment penalties.

One of these is better known as the “safe harbor” provision set out in IRC Section 6654(d)(1)(b).

IRC section 6654(d), titled Amount of Required Installments, provides that the amount of any [quarterly] required installment (or estimated payment), “shall be 25 percent of the required annual payment. (IRC section 6654(d)(1)(A))

Under subparagraph (d)(1)(B) of the same section, the “required annual payment” means the lesser of

(i)            90 percent of tax shown on the return for the taxable year (or, if no return is filed, 90 percent of the tax for such year) or
(ii)           100 percent of the tax shown on the return of the individual for the preceding taxable year

Clause ii shall not apply if the preceding taxable year was not a taxable year of 12 months or if the individual did not file an income tax return for such preceding taxable year.

Subparagraph (d)(1)(C) imposes a limitation on the clause ii safe harbor:

(i)            In general. If the adjusted gross income shown on a return for an individual is for preceding taxable year beginning in any taxable year exceeds $150,000, clause ii of subparagraph (B) shall be applied by substituting [110] percent for “100 percent.”

In effect, the question is directly related to clause ii of subparagraph (B) as referenced above.

The required annual payment is 100 percent of the prior year tax. This is only the case if the taxpayer is filing as a single unmarried individual. In addition, if the prior year return includes adjusted gross income greater than $150,000, the required annual payment is 110 percent of the prior year tax shown on the return.

The case differs slightly if the taxpayer is filing jointly with a spouse. In this case, all of the thresholds noted in the previous paragraph are correct, but the safe harbor is applied to the “combined” adjusted gross income of the couple. Thus it is easier to hit the $150,000 adjusted gross income threshold sooner and, as such, be required to pay total estimates at 110 percent of the prior year amounts.

Finally, if the taxpayer is married, but chooses to file married-separate, the $150,000 threshold drops to $75,000, and in that instance, the 110 percent rule applies. (IRC section 6654(d)(2)(C )(ii))

It is noteworthy that to take full advantage of the prior year tax safe harbor (either at 100 or 110 percent), taxpayers are required under this section of the IRC to pay the “annual amount” in four 25 percent payments. Generally, paying disproportionate quarterly estimated tax payments will not suffice to remediate the entire penalty. However, in this instance, any penalty assessed will be based on the quarterly shortfall against 25 percent of the prior year tax liability and not the higher expected 2013 income tax liability.

Answer By: Robert J. Grossman, CPA, is a partner with tax and business valuation services for Grossman Yanak & Ford LLP in Pittsburgh. 
The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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