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Last year my self-employment income was $300k and I paid about $80k in federal taxes.

This year, in the first quarter, all of my business dried up and I had $0 in income. Turbo tax was advising me to make an estimated tax payment of $20K on Apr 15th, but I had no income from which to pay this amount.

In May I got a huge contract, and business surged, so I will now make a $40K payment by Jun 15th. But as I understand the rules, I will owe a penalty and interest to the IRS as a result.

Question: I understand that the IRS wants their cut of your income on a quarterly basis, but how can I pay them a cut of income I didn't make? And am I correct that I have now broken the rules and will incur penalties?

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You will not necessarily incur a penalty. You can potentially use the Annualized Income Installment method, which allows you to compute the tax due for each quarter based on income actually earned up to that point in the year. See Publication 505, in particular Worksheet 2-9. Form 2210 is also relevant as that is the form you will use when actually calculating whether you owe a penalty after the year is over.

On my reading of Form 2210, if you had literally zero income during the first quarter, you won't be expected to make an estimated tax payment for that quarter (as long as you properly follow the Annualized Income Installment method for future quarters). However, you should go through the calculations yourself to see what the situation is with your actual numbers.

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    Good answer. Note also that not just earned income but all income counts towards the quarterly computation that determines whether you owe estimated tax--i.e., the OP needs to look not only at his business income but also at interest, dividends, etc. from investments. Form 2210 is tedious but straightforward to fill out--unfortunately it's too esoteric for consumer-level tax software like TaxCut and TurboTax to include an automatic version, so you have to do it manually. – dodgethesteamroller Jun 10 '15 at 16:17
  • I should add that there's no harm in not filing Form 2210, or, indeed, not paying any estimated taxes at all. The IRS is perfectly happy to take the interest and penalties along with your regular tax payment on April 15 next year. when I worked for a CPA one tax season during business school, I was surprised to see how many clients with incomes that fluctuated during the year (usually because they owned several small businesses) just didn't bother to collect the records needed to file accurate estimated taxes every quarter--they thought the penalties and interest were the lesser evil. – dodgethesteamroller Jun 10 '15 at 16:24
  • @dodgethesteamroller: That depends what you mean by "no harm". I think most people would consider monetary penalties harmful. You're right that the hassle of computing estimated tax payments could also be considered harmful, and that you can decide which harm you want to suffer. But I think even so you'd probably want to do some calculations to get a ballpark idea of what the penalties are going to cost you. – BrenBarn Jun 10 '15 at 16:29
  • Good point. As I indicated in my second sentence, you will have to pay interest and penalties if you owed estimated tax for any quarter other than Q4 but did not pay it. By "no harm" I meant only that I've never seen or heard of a case where someone was charged with a crime, audited, or otherwise persecuted by the IRS for not making estimated tax payments, so long as they paid any interest and penalties due along with a timely filed return. (Disclaimer: IANAL!) – dodgethesteamroller Jun 10 '15 at 19:35
  • @dodgethesteamroller, over in the US, roughly speaking how high is the extra fee if you simply DON'T pay the quarterly estimated taxes? so, say the guy made $300k and full tax is $100k, just for example. He deliberately did not pay estimated tax once of the four times. At the end he pays of course the whole $100k. What is the extra penalty, roughly?? cheers! – Fattie Jun 2 '16 at 15:19
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Well a definitive answer would require a lot of information. Instead of posting that kind of info online, you should take a look at the instructions for Form 2210 and in particular "Schedule AI -- Annualized Income Installment Method," which corrects the penalty for highly variable income.

Using this form you will likely be able to avoid the penalty, but it is hard to know for sure.

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