We wrap up our tax planning series today with an overview of tax payments and penalties. Throughout this series, we’ve explored aspects of tax planning starting with Tax Code Basics, then moving through Tax Brackets, Capital Gains, and then a dive into strategy for Standard vs. Itemized Deductions.

As with many items in our tax code, getting your taxes paid is more complex than it would seem.

Understanding the Basics: Payments & Penalties

Let’s start with the three ways that you can pay your taxes. Each of these methods impacts your tax outcome differently, as the IRS’s rules are not just limited to how much tax you pay, but also, when you pay it. The timing of tax payments is one factor that can cause tax penalties.

Methods to pay your taxes:

1. Withholding – You have federal income tax withheld on your paycheck or other forms of income, such as pension payments and IRA withdrawals.

1. Estimated Payments – You submit a payment or payments throughout the year to pay in tax on income where tax does not get withheld, such as business income or investment income.

1. At Tax Filing – You pay in additional tax owed when you file your taxes in April (or later if you have an extended return)

In fact, it is even possible to get a refund at tax filing time but still have a tax penalty due to the timing of your payments!

Timing is Everything

All three methods, withholding, estimated payments, and paying at tax filing, are viable methods of payment but are seen differently by the IRS due to their timing.

Let’s look at how each method of payment described above affects the timing of payments:

1. Withholding – If you have taxes withheld from your pay, they are considered to have been paid evenly throughout the year, even if your withholding changed during the year. This means that there is not a timing issue if your only methods of income have tax withheld. However, you still have to make sure you have enough tax withheld throughout the year to avoid an underpayment penalty.

1. Estimated Payments – These payments are made at the time they are sent in. Typically, estimated payments are due in April, June, September, and January for the tax year. So, if you decide to wait until the beginning of the following year and make an estimated payment in January, you are risking a timing penalty, even if you pay in enough estimated tax.

1. At Tax Filing – You can wait until tax filing time to pay the tax you owe, but this will also subject you to the risk of a penalty due to timing, depending on how much you owe.

To avoid tax penalties for timing of payments, you should plan out your year of payments with your tax professional ahead of time. This is especially important if you own a business, have multiple sources of business income, or significant investment income outside of retirement accounts.

Other Strategies for Tax Payments to Avoid Penalties 

Assuming you have your timing planned appropriately, you can also avoid a penalty for underpayment of tax by meeting the IRS’s “Safe Harbor” amount for the year.

Safe Harbor states that as long as you pay 90% of your current year’s tax liability during the year (and at the correct times) OR 100% of your previous year’s tax liability, you will not pay penalties. This percentage increases to 110% if your Adjusted Gross Income is over $150,000 for married filing jointly or $75,000 for single/married filing separately.

Master’s Strategic Planning Support

When you have variable income, such as business income, the timing and amount of tax payments are important components to proper tax planning. We need to pay what we owe, but we certainly don’t need to leave a tip!

Master’s specializes in helping our clients achieve their goals while helping them think more strategically about their tax situation, empowering them to live their life of purpose. If you or someone you know could benefit from our assistance, contact us today to explore how we can help you think strategically about your taxes and plan for a more secure financial future.