How To Prevent Penalties for 4th Quarter Estimated Tax Payments

Meeting your tax obligations conscientiously can seem challenging, particularly in the often misinterpreted realm of estimated tax payments.

Frequently, taxpayers, especially those with income not subject to withholding like self-employment, investment, or rental income, overlook making 4th quarter-estimated payments.

When this happens, penalties can ensue. Why does it matter?

Imagine this scenario: You are a freelance photographer juggling clients, shoots, and editing.

Suddenly, because you've overlooked your 4th quarter estimated payments, you're now saddled with unexpectedly high penalties dramatically biting into your hard-earned profit.

This can result in severe stress, throw your carefully calculated budgeting off track, and lead to persistent instability regarding finances.

Don't worry; this article will help you understand and navigate this complex issue.

Let’s dive in!

What Is the 4th Quarter Estimated Tax Payment?

An estimated tax payment is a quarterly payment made to the IRS throughout the year based on the taxpayer's estimated income. The 4th quarter estimated tax payment, due by January 15, is the final prepayment for the preceding year's tax liability.

Assuming regular quarters, taxpayers generally make these payments in April, June, September, and January of the following year. Irregular income earners, like our freelance photographer example, are highly suggested to use estimated tax payments to avoid year-end publicized tax headaches.

Avoiding penalties involves adhering strictly to set deadlines, making accurate calculations, complying with a metrics-driven strategy, and understanding the basis for estimation.

For example:

If your annual taxable income is assessed at $50,000, each payment is 1/4 of the estimated tax. Calculation errors in each quarter, particularly the 4th tranche, can lead to the inevitable downfall of having to pay penalties.

Everyone earning an income must report it on their 1040 Form. However, estimated taxes are only compulsory for gig workers, self-employed individuals, small business owners, freelancers, 1099 workers, and independent contractors who expect to owe at least $1,000 in taxes over the year. This must be reported on the IRS Form 1040-ES.

As you know, America's tax system is pay-as-you-go; this means you must pay income tax as you earn or receive income during the year, either through withholding or estimated tax payments.

For salaried employees, tax is often withheld from their paychecks and remitted to the IRS by their employer. This means they're already incrementally contributing toward their year-end tax liability with each pay period.

For those who don't have taxes taken out of their paychecks or have enough tax withheld, making estimated tax payments is crucial to avoid underpayment penalties.

When Are Estimated Tax Payments Due in 2024?

As a taxpayer, you must pay 1/4 of your estimated annual tax liability on the four due dates throughout the year.

So, for income earned between September 1 to December 31, the deadline for the 4th quarter estimated tax payment falls on January 16, 2024.

If that date happens to be a weekend or a legal holiday, the payment is due on the next business day.

Making timely payments is not just about avoiding penalties; it also provides peace of mind. It's part of maintaining a reputable financial profile, which is valuable for any independent professional trying to establish a steady work stream.

Who Needs To Make Estimated Tax Payments?

Small business owners operating as LLCs, S Corporations, partnerships, or sole proprietorships typically need to make estimated tax payments. However, there is an exception to this rule.

Here’s how you can gauge that:

  1. Is your total tax liability (after any withholding and credits) above $1,000? If not, you don't need to pay the estimated tax.
  2. Will your income tax withholding and credits equal at least 90% of your total tax liability for this year? If not, then you are not required to make estimated tax payments.
  3. If your last year's adjusted gross income was more than $150,000 ($75,000 for married filing separately), you must ensure that your income tax withholding and credits are at least 110% of the tax shown on your last year's return. Otherwise, you are not obligated to pay the estimated tax. If that requirement is met, estimated tax payments must be made.

Estimated tax for corporations

If your business is a corporation, estimated tax payments must be made if the tax liability is expected to exceed $500 in a year. If the installments of estimated tax do not meet either 100% of the tax on the previous year's return or 100% of the actual or estimated tax on the current year's return, a penalty of underpayment will generally be enforced.

How To Determine the Estimated Tax Payment Amount

  • Estimate your upcoming tax bill by looking at each item on your current tax forms and schedules.
  • For example, if your office's real estate tax bill is due to rise by 10%, that will decrease the net income reported on Schedule C and increase the itemized real estate tax deduction on Schedule A.
  • Factor in other changes to estimate your total tax bill.
  • Subtract your withholdings from the amount and deduct $1,000 from the result. This is the estimated tax you need to pay.

How To Pay Estimated Tax Payments

Making your estimated tax payments is straightforward. You can pay online using the IRS Direct Pay service, by credit card, or through the Electronic Federal Tax Payment System (EFTPS).

Alternately, you can pay by check or money order by mailing your payment along with a completed IRS Form 1040-ES voucher.

To stay organized and avoid penalties, it's crucial to keep a detailed record of all payments including dates and amounts. If you overpay, you can apply the overpayment to the next year's estimated tax or request a refund. It's important to consult with a tax professional or utilize trusted tax software to ensure your payments are calculated correctly.

Estimated Tax Penalties

If you underpay your IRS estimated tax payments, you may face a penalty of 0.5% of your unpaid balance per month (up to 25%). You'll also accrue interest on the unpaid amount.

However, you can bypass the penalty altogether with the estimated safe harbor rule. To calculate the smaller payment amount, pay either 100% of your 2021 taxes if your adjusted gross income is below $150,000, or 90% of your 2022 taxes.

This doesn't guarantee you won't owe more taxes for 2022, so make sure to set aside funds for federal and state taxes. If you face a penalty, use a tax penalty calculator to estimate the total.