Best way to pay US Federal taxes on unpredictable royalty income on time throughout the year?

Question

My wife collects some income in the form of royalties on a book. What I've read seems to indicate that we should try to estimate quarterly income and pay quarter-to-quarter. However, because her royalties can vary unpredictably as much as two orders of magnitude year to year, it would seem to be an onerous burden to try to estimate quarterly income from the royalties. We'd probably either drastically over estimate--over burdening ourselves with a large quarterly tax bill, or we'd under estimate--ending up penalized at tax time.

I would prefer a system whereby when we get a large royalty check, we immediately write a check for 1/3 or so to the IRS and consider that our estimated tax payment, then settle up at tax time. Is this reasonable? How would I do this? I can't seem to find any information on such a system--all I see is the information on estimating quarterly income for self employed individuals.

Whats the best course for someone who has sporadic, unpredictable income and they want to be sure to pay taxes on time?

Answer 1

If you truly don't know how much income you're going to get throughout the year, or when, then it's probably far easier and safer to base estimated tax payments on last year's tax liability. It's a known amount. The magic numbers are:

• 100% of your tax liability from the previous year, if you made less than $150k in the previous year
• 110% of your tax liability from the previous year, if you made more than $150k in the previous year

That way, you're safe regardless of how much comes in this year.

More information here and here.

Answer 2

The simplest way is to do what mbhunter suggests and paying 100% or 110% of your previous years income which is pretty simple and will allow you to avoid the penalty.

However paying 100% of previous years taxes could be a heavy financial burden if you have a really good year followed by a rather poor year. Your other option is to pay quarterly estimated taxes based on the amount of income that you received in that quarter. When tax time comes you can use IRS form 2210 to show when you earned the income and paid the taxes on it. The only downside is that some/most tax software doesn't support form 2210 or at least they didn't 2 years ago when I had to file it.