What prevents me from making one big estimated Federal tax payment on Jan 15?

Question

Many places claim that I must pay estimated tax, preferrably in equal installments, throughout the year. There are two weird issues around this that I am trying to make sense of.

My tax situation is that I mostly rely on employer withholdings, but I have to pay extra for the additional income, which is uneven throughout the year.

1. What prevents me from paying the entire estimated tax on Jan 15, 2023, if I make sure I hit 90% of the total 2022 tax (or 100% of 2021 tax, whichever is smaller)? Like, quarters 1,2,3 - zero, quarter 4: top it up to 90%. Per form 2210, I would not owe any penalty then. Are there some additional instructions by which the IRS will get me?

2. Is it true that with equal payments, I can be hit with substantial underpayment penalty if I miss the 90% threshold even by a little bit. The 2nd quarter is actually 2 months, but I am expected to pay 3 months worth of taxes. Here's how it works.

My (fictional) total tax liability for 2022: $24,000 a year.
                                              $2,000 a month.
The employer withholds:                       $1,700 a month. 
To avoid the penalty I must pay:              $1,800 a month
Estimated tax to avoid the penalty:             $100 a month
                                                $300 per quarter.
Estimated tax actually paid:                    $299 per quarter.

For the 1st quarter (Jan-Mar) all looks logical:

Required tax:                  $6,000
Amount to avoid the penalty:   $5,400
Employee withholding 3 months: $5,100
Estimated tax:                   $299
Underpayment:                      $1, not a big deal

But for the 2nd "quarter" (Apr-May):

Required tax:                  $6,000
Amount to avoid the penalty:   $5,400
Employee withholding 3 months: $2,400
Estimated tax:                   $299
Underpayment:                  $1,701. Oops :(

Of course, there will be overpayment in quarter 4, but I would still owe 3 months of interest on $1700.

Thus, even if I make equal installements, it is quite dangerous to be even a little off the 90% mark, so why not just pay it as a lump sum in January (back to question 1)?

Answer 1

if I make sure I hit 90% of the total 2022 tax (or 100% of 2021 tax, whichever is smaller)? Like, quarters 1,2,3 - zero, quarter 4: top it up to 90%. Per form 2210, I would not owe any penalty then.

If by "hit 90%", you mean with withholding plus estimated tax, but not with withholding alone, then what you said is incorrect.

Let's look at the 2021 Form 2210. Line 9 is the safe harbor amount (smaller of 90% of current year tax or 100%/110% of last year's tax). Line 6 is the withheld tax only, not including estimated taxes. Since your withholding alone does not reach any of the safe harbors by the end of the year, line 9 is greater than line 6, so you have to check the "Yes", box, and continue onto the penalty computation.

For line 10 (required installments), you will put 25% of the safe harbor level in each of the quarters (unless you choose to use the Annualized Income method, which can give you lower required installments if your income is weighted towards the end of the year). For line 11, enter the tax withheld and estimated taxes paid for each quarter; 25% of the withholding is considered to be paid each quarter (unless you can show the date it was withheld, in which case you can count the actual amounts withheld by the estimated tax due dates).

So basically, if you did not pay estimated taxes for the first 3 quarters, line 11 for the first 3 quarters will be withholding only, which will be less than line 10 for the first 3 quarters. When you go through the calculation, you will get an underpayment in line 17 for each of the first 3 quarters, and you will calculate an underpayment penalty for each of the first 3 quarters.

Answer 2

In the US income taxes should be paid when income is earned.

The IRM specifically calls out:

Taxpayers are generally required to pay income tax as income is earned. This is accomplished via withholding from income or via estimated tax payments. Taxpayers who do not have sufficient amounts withheld and who fail to make estimated tax payments as required by law may be assessed a penalty for underpayment of estimated tax.

The IRM is what guides the IRS Revenue Agents when assessing penalties. The section I linked to (IRM 20.1.3) deals with the underpayment penalties.

Withholding from salaries help ensuring that, but as you mentioned due to income outside your salary earnings withholding calculated by your employer may not be enough.

Technically you can pay one big lump sum on Jan. 15th after the year ended, since then you'll know how much you've earned for the entire year. But, you will not be complying with the law requiring you to pay as you earn.

The law allows you to pay in 4 installments (not exactly quarterly, as you've noticed) throughout the year, and prescribes how the amounts should be calculated. There are several various safe-harbors, including salary withholding (See IRC Sec. 6654).

The 90% of the total tax liability for the year is one of the safe harbors. Another one is 100% of the last year's tax liability.

In most cases, you must pay estimated tax for 2022 if both of the following apply.

• You expect to owe at least $1,000 in tax for 2022 after subtracting your withholding and tax credits.
• You expect your withholding and tax credits to be less than the smaller of:
  • 90% of the tax to be shown on your 2022 tax return, or
  • 100% of the tax shown on your 2021 tax return. Your 2021 tax return must cover all 12 months.

(If your AGI is above $150K ($75K for MFS) then it's 110%.)

That safe harbor is easier to achieve since you know exactly the amount and you can calculate your quarterly estimate amounts to match it exactly. So if you're concerned about fluctuations of your income and inability to hit the 90% mark of the current year's tax liability - use that other option.

Answer 3

1. You could still be penalized. Look at Part III of Form 2210. You can have an underpayment on Line 17 columns a, b, and c, even if you make a payment in January to reach one of the safe harbors.
2. If you only miss the threshold by a little bit, you only get penalized on that little bit. It's not like if you just miss the threshold, you're treated the same as if you had made no estimated tax payments.

In general, unless you're going to come up way short of one of the safe harbors, I'd recommend increasing your employer withholding instead of making estimated tax payments. The IRS doesn't look at the distribution of employer withholding like they do with estimated tax payments, so even if you increase your withholding at the very end of the year to hit a safe harbor, according to the form there'd be no penalty (of course, if it's really egregious the IRS might ask questions). This is especially relevant since the first estimated tax deadline for 2022 has already passed and the second is quickly approaching.

Answer 4

Firstly, I suspect you actually mean the 15 April estimated tax payment, not the 15 January one. The 15 January one is for making payments on earnings in the previous year's Oct, Nov, and Dec, and is considered the final of 4 quarterly estimated payments for that year previous. The 1st estimated tax payment of the new year is due at the same time as the tax filing deadline, 15 April or thereabouts (depending on weekends, holidays, it will move about a day or two).

Secondly, practically, there is nothing preventing you from overloading that 1st estimated tax payment. In fact, if one gets a refund, one may choose instead of taking the cash to just roll that into your estimated tax payment for 15 April. The federal government is happy to hold that cash for you, if you so choose. As noted in the other reply, this isn't really optimal, but if you have the means and want the peace-of-mind, then sending in a single large lump sum will be accepted just fine.