I've read that you'll owe a penalty if you don't pay enough in taxes during the year, and I'd like to avoid paying estimated taxes if possible since I have significant and hard-to-predict investment income. According to the IRS:
Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.
Assuming you owe more than $1000 and you receive investment income which is tough to estimate in advance, and will certainly result in paying less than 90% of the taxed eventually owed, how do you meet the last criteria, ie paying 100% of the tax from the prior year?
Specifically, where on one's prior year return do you find this 'tax' number? Is it line 63 on the Form 1040? Once you know this number, what is the proper way to handle it? Would doing the following be correct? :
- Get 2019 tax paid (withheld from paycheck) estimate as follows: find the line that says federal tax deduction on paycheck, multiply this by 26 (paycheck is once every 2 weeks)
- Get 2018 tax (Line 63??)
- Calculate "Gap" as 2018 tax minus 2019 tax paid estimate
- Calculate "Gap" divided by remaining paychecks in calendar year, and enter this value on line 6 of an updated W-4
For example, if I determined my 2018 tax was $20K, used my last paycheck from my employer to compute my eventual total 2019 federal witholding as $18K, calculated the difference as $2K, and assuming there were 10 pay periods left in the year, determined I needed $2K/10 = $200 in federal taxes taken out of each of my remaining paychecks by updating my W-4 to include $200 on line 6 (or better yet 110% of $200 or $220 to give myself a bit of safety cushion)
Does this sound correct? Basically I'm trying to make it so that my 2019 federal tax deductions from my paycheck meet or exceed my 2018 tax (because I don't want to have to estimate my investment income and make quarterly payments to the IRS)