Renner Individual News; July 13, 2022

If you’re like many individual taxpayers, you probably find quarterly estimated tax payments a fundamental challenge. 

You owe tax on your income as you earn it, throughout the year. However, you don’t know for sure how much tax you owe until you complete your return, after the year is over. Pay too much, and you may be strapped for cash. Pay too little, and you may owe late payment penalties when you file your return.

On top of that, 2022 poses some unique challenges for taxpayers.

With the stock market down right now, some are reluctant to take out more money than necessary for that third quarter payment.

Now is a good time to brush up on the estimated tax payment requirements.

What is the best way to comply?

It depends. If you are an employee, it is fairly easy to pay in your tax on time. Your employer is required to withhold your tax from each paycheck. With the right amount of withholding, you shouldn’t owe much with your return.

If you have income not subject to withholding, like investment, rental or business income, you will need to pay quarterly tax payments throughout the year to reach the magic number.

How much tax should I pay in?

To avoid a penalty with your return, you need to have paid in at least 90% of your current year’s tax through withholding or timely estimated payments.

Hitting this number with timely quarterly payments is a challenge for many because you’re required to pay a definite amount of tax on an uncertain amount of income, and do it on time. Miss the target and you’ll owe late payment penalties.

How can I get some certainty?

You can reduce your risk of late payment penalties by using a safe harbor method provided by the IRS. As long as you pay in 100% of what you owed for the previous year, through withholding and timely estimated tax payments (110% for higher-income taxpayers), you will be protected from a late payment penalty. You can calculate these “protective estimates” as soon as your prior year tax return is completed. 

How can I avoid overpaying?

Although the safe harbor method protects you from late payment penalties, it may lead you to overpay.

“The biggest challenge is, in order to be penalty proof, you need to have 110% of last year’s tax paid in, which is a high number because of the large capital gains in 2021,” said John J. Renner, II, CPA and founder of Renner and Company. “The estimates that were prepared in April were based on last year’s tax.” 

With investment returns down in 2022 and a decline in the economy on the horizon, your 2022 taxable income may not be as high as 2021.

With the first two quarters of estimated tax payments under your belt, you may want to think about your 2022 taxable income before paying that third quarter payment.

“Do a tax projection now and you can adjust your quarterly payment,” Mr. Renner said. “It’s good to take a look at it in September and again at the end of year just to make sure you’re covered.

“You may not have to make a third- or fourth-quarter payment. You may have enough paid in. It helps with cash flow and, with inflation (right now), cash is very important.”

Now is a good time to:

  • Get started on a tax projection for 2022 to assess the adequacy of your withholding and 2022 estimated tax payments. You may be able to reduce your third- and fourth-quarter payments.
  • Talk to your investment advisor about expected 2022 investment income.
  • If you have a business, get your 2022 accounting up to date and update your estimate of 2022’s taxable income.

There’s more to know on this topic. As always, you can contact us for help with your 2022 estimated tax payments.

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