Underestimating Taxes

Cdbob | Feb 8, 2023 | 49 posts since 2017

Because of the increased rates on cd's last year many people underestimated their 2022 quarterly federal (and state) estimated tax payments, myself included. I was under the impression that as long as your 2022 estimated payments were more than your 2021 taxes you wouldn't be penalized for underestimating your payments. True or not true?

It becomes rather difficult to estimate ones yearly earned interest when rates are changing so quickly. Any comments?

Post an answer

Answers

Sylvia | Feb 8, 2023 | 389 posts since 2012

Some additional info:

* The safe harbor related to prior year income is 100% only if AGI is no more than $75K for single/separate filers or $150K for married filing jointly, otherwise payments must equal or exceed 110% of prior year tax bill.

https://turbotax.intuit.com/tax-tips/small-business-taxes/estimated-taxes-how-to-determine-what-to-pay-and-when/L3OPIbJNw

* Penalty rate applied to underpayment is determined quarterly. Annual rate used for the 4th quarter of 2022 was 6%; for current quarter, it’s 7%, compounded daily.

https://www.irs.gov/newsroom/interest-rates-increase-for-the-first-quarter-of-2023#:~:text=7%25%20for%20overpayments%20(payments%20made,owed%20but%20not%20fully%20paid)

Cdbob | Feb 8, 2023 | 49 posts since 2017

Thanks again Sylvia, I didn't know that. I'll do 110% from now on.

Sylvia | Feb 8, 2023 | 389 posts since 2012

“You may avoid the Underpayment of Estimated Tax by Individuals Penalty if:
* Your filed tax return shows you owe less than $1,000 or
* You paid at least 90% of the tax shown on the return for the taxable year or 100% of the tax shown on the return for the prior year, whichever amount is less.”

https://www.irs.gov/payments/underpayment-of-estimated-tax-by-individuals-penalty

GH1 | Feb 8, 2023 | 1,053 posts since 2017

Thanks Sylvia but most people probably did not realize they were underpaying and now get penalties. I did not file yet but because of a death in family I have now probably underpaid. But I do believe there is a cap on penality of 5 percent. So much for earned interest. It's take it back

Cdbob | Feb 8, 2023 | 49 posts since 2017

Thanks Sylvia, I guess I'm safe as I paid 100% of the tax shown on the return for the prior year. Next year I need to bump up my estimated payments substantially to avoid a large payment to both fed and state at tax time. I know that it benefits me to write that big check, but I try to estimate it pretty close and it becomes difficult when rates are changing so quickly. Last year I missed the 90% rule by a substantial amount.

Kaight | Feb 8, 2023 | 1,192 posts since 2011

You're good provided you paid the safe harbor amount timely. What I do is to divide the prior year total tax by four and then pay at least that amount with each quarterly payment. That way you cannot be taken by surprise and you will be OK regardless any increase in the tax owed for the present year.

But the timely part above is important. Using 2022 and 2023 as an example:

It's not good enough to have paid your 2022 tax total in full once your January 2023 estimated payment is complete. You cannot chintz out, for instance, on your April and June 2022 estimated payments and then make up for the shortfall come September of 2022 and/or January of 2023. Instead the quarterly payments are considered individually and each must pass muster on its own. If that does not happen a penalty could ensue.

Cdbob | Feb 8, 2023 | 49 posts since 2017

Good point Kaight, I did that, made up the shortfall, one year because I unexpectedly cashed a few EE savings bonds late in the year and I knew I was going to be short on my estimate. I included a letter with my taxes stating the reason I was short and the IRS waved the penalty. I try to do it right because dealing with the IRS is stressful and time-consuming to say the least!

sams1985 | Feb 8, 2023 | 781 posts since 2022

What kind of penalties are we looking at if you under pay by apprx 5-6k?

Choice | Feb 8, 2023 | 937 posts since 2020

It's not just the amount but the timing, i.e.has to be paid over the entire year. Of course, "you youngsters" won't have that problem later with RMDs from IRAs when/if taxes are withheld...they are deemed withheld over the entire year, ergo, do the latter in December!

Kaight | Feb 8, 2023 | 1,192 posts since 2011

Like everything else tax rules related, this safe harbor thing is FUBAR. I wonder if they do this purposefully to ensure we remain in a constant state of confusion. Regardless:

Here is the exact wording on the 110% rule from the instructions for IRS Form 2210 which, incidentally, is the penalty box for estimated tax underpayers:

Higher income taxpayers. If your adjusted gross income (AGI) for 2021 was more than $150,000 ($75,000 if your 2021 filing status was married filing separately), substitute 110% for 100% in (2) above.

So presumably if you're married filing jointly, or if you're single, the 110% threshold is $150,000. Only if you're married filing separately does the lower $75,000 threshold apply.

That does appear to be a bit counterintuitive. But there is never a dull moment in this life!

ETA

Here is a link to those penalty box instructions for 2022:

https://www.irs.gov/instructions/i2210

IRS Form 2210 itself? I looked. It's a nightmare!!

Cdbob | Feb 8, 2023 | 49 posts since 2017

I looked also and "WOW"! Talk about a time consuming confusing mess. No thanks!

The financial institution, product, and APY (Annual Percentage Yield) data displayed on this website is gathered from various sources and may not reflect all of the offers available in your region. Although we strive to provide the most accurate data possible, we cannot guarantee its accuracy. The content displayed is for general information purposes only; always verify account details and availability with the financial institution before opening an account. Contact [email protected] to report inaccurate info or to request offers be included in this website. We are not affiliated with the financial institutions included in this website.