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I'm trying to plan out how I'm going to handle my US estimated taxes for 2017. I'm self employed and the amount of money I make each month varies quite a bit and is generally unpredictable, so it's not feasible for me to base my estimated tax payments off of last year's income -- I may end up making a lot less money than I did last year! While I am aware that the annualized income installment method is the preferred way to handle this, I'm wondering if I'm going to be penalized for doing the following:

  1. For my 1st quarter estimated taxes, I calculate my annualized income based on income from January - March, calculate the year's taxes based on that, and pay 1/4 of it. (Fairly standard.)

  2. For my 2nd quarter estimated taxes, I calculate my annualized income based on income from January - May (five months), calculate the year's taxes based on that, and pay 5/12 of that total minus my 1st quarter estimated taxes.

  3. For my 3rd quarter estimated taxes, I calculate my annualized income based on income from January - August (eight months), calculate the year's taxes based on that, and pay 8/12 of that total minus my 1st and 2nd quarter estimated taxes.

  4. For my 4th quarter estimated taxes, I take my actual income for the year, calculate the year's taxes based on that, and pay off the rest (i.e. the total minus my 1st, 2nd, and 3rd quarter estimated taxes.)

First, is this actually different from the annualized income installment method? (I'm having a hard time understanding exactly how it works.)

Second, this has a number of advantages that I like. For one, it has me pay very, very close to the actual total amount of taxes owed through all of my estimated taxes. Second, and more importantly, it takes into account the uneven distribution of estimated tax payment dates, so that I don't have to pay three months worth of taxes from two months worth of income in June. The last couple of years that's been hard for me to manage.

However, I'm worried I'm going to get penalized for doing this since it's (probably) non-standard. I tested it out by throwing in some numbers into TurboTax that reflect what I would've paid in estimated taxes had I done this for 2015, and it says my penalty is less than $10. I can live with that. But that's just from one test, and I'm not sure if there's other issues with doing this. For example, does it increase the chances of an audit? Or is there a possibility the penalty could be much higher?

Overall, is this a reasonable method for paying my estimated taxes?

edit:

I've confirmed that this is different from the annualized income installment method. It looks like I'm unlikely to incur much in the way of underpayment penalties using this method, but I'm still interested in hearing people's opinions.

  • Yes the 'quarters' vary; you have to pay June and Sept about 15 days before you've finished earning the money which the payment covers, while for April and Jan you get to wait until 15 days after. Plus when the 15th falls on a weekend or holiday you get at least one day extra. But you're paying 5/12 and 8/12 of 100% versus the standard 2/4 and 3/4 of 90% so I expect you won't be under by much. Self-employed is by itself an audit risk (because so much more opportunity for misreporting) but I doubt exact pattern of estimated payments adds anything to it. – dave_thompson_085 Sep 16 '17 at 0:13
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Estimated tax payments should be a reasonable estimate of what you owe for that time period. If it seems reasonable to you, it is probably reasonable. Sure, you can adjust for varying-length periods.

As long as, in the end, you can and do pay what you owe, and don't underpay the estimated/withholding by enough that you owe a penalty, the IRS isn't all that picky about how the money is actually distributed through the year.

  • Can you help me understand how the penalty is calculated? I've tried searching around for more information but I've yet to find something that is clear and comprehensible to me. – GuyGizmo Oct 6 '16 at 21:34
  • Yes, I just decided to make four equal payments at unequal periods through the year. It seemed simpler to do it that way -- for me. – Peter K. Oct 7 '16 at 0:23
  • Similarly, the one time I was asked to do estimated payments on my personal tax, I knew that the previous year was an exception and that I had adjusted my withholding to give myself more buffer... So I completely skipped sending in the estimated forms, and since the withholding was more than sufficient and I was owed a refund the IRS had no objection. – keshlam Oct 7 '16 at 1:04
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As long as you paid 90% of the taxes you owed, you are good, and there will be no negative consequences.

These calculations are supposed to help you find the right amount, not to bind you to it, so you don't need to worry too much about exactness. The most common problem is that people underpay, and not come up to the 90% limit (and don't have the cash to pay when tax-day comes).

If you happen to come in under 90% (which will come out when you file taxes), you will owe interest for the underpayment (as you should have paid it some time ago); typically 0.5% per month; also up to 10% in addition, depending on the situation. This is expensive, so you should avoid it; and playing to hit 90.01% is dangerous - better try to hit about 100% and use the 90% limit as safety margin, as intended.

  • I am trying to hit 100%. However I do believe you can be charged an underpayment penalty for not paying the correct amount for each of the four estimated tax installments. The way I'm doing it means that my 2nd quarter payment will be smaller than the annualized income installment method would have me pay, and I will be charged a penalty for that underpayment as well as what isn't covered by the 3rd payment. At least, that's what I gathered when I looked at how the penalty was being figured by TurboTax when I put all the numbers in. (Do correct me if I'm wrong!) – GuyGizmo Oct 7 '16 at 15:48
  • The 2210 'penalty' is actually computed as interest, per day at a rate based on Treasury market rates measured AFAICT shortly before the year begins, which for 2016 was 4%. OTOH payment delayed after April 15 (or next business day) is charged the 'failure-to-pay' penalty 0.5% per month or part (0.25% if you are complying with an Installment Agreement) to a max of 25%, plus interest at the more-or-less market rate. @GuyGizmo: if you want to look at the actual calculation, you can download form 2210 and its instructions from the IRS website (including for past years if you want). – dave_thompson_085 Sep 16 '17 at 0:34

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