Last March, attorney Michael Avenatti, who is best remembered for his representation of actress Stormy Daniels, proved that failure to make estimated tax payments is a bad idea. In addition to being charged with providing false tax returns for 2011-13 in order to receive $4.1 million in loans, the U.S. Attorney’s Office in Los Angeles stated that Avenatti failed to file personal income tax returns for those years and made no estimated tax payments in 2012 and 2013.
When you earn or receive income throughout the year, you are obligated to pay taxes on that money. If you receive a paycheck or a pension, tax is typically withheld from those payments, but when your income is from sources like self-employment, you may have to make estimated tax payments, which are a series of quarterly prepayments based on the amount earned and its estimated tax liability.
Who Has to Pay Estimated Tax?
Individual taxpayers (this includes sole proprietors, partners, and shareholders in an S corporation) are generally required to make estimated tax payments if they owe tax from a prior year and/or expect to owe at least $1,000 in taxes when they file their return. Corporations make these payments if they expect to owe at least $500 when their return is filed.
In general, you have to make estimated tax payments if your income is from sources like the following:
- Capital gains
- Financial awards and prizes
If the amount of income tax withheld from your paycheck or pension is insufficient, you may also have to make estimated tax payments. Failure to do so may result in penalties that can add up quickly.
How do Estimated Tax Payment Penalties Work?
IRS Notice 433 explains the rate of interest applied to the underpayment of estimated taxes as well as overpaid or underpaid taxes. As per federal law, it is determined on a quarterly basis, and for all taxpayers except corporations, the underpayment rate is the federal short-term rate plus three percentage points.
According to the IRS, the rates for the current quarter are:
- 5% for most underpayments
- 7% for underpayments made by large corporations
If you miss a filing deadline, it will cost you an additional 5% of the unpaid balance each month, and failing to pay what you owe adds an extra 0.5% on top of that. If you’re unable to resolve the debt immediately, it adds up fast.
Can Estimated Tax Payment Penalties Be Waived?
The IRS may waive your estimated tax payment penalties if any of the following conditions apply to your situation:
- You owe less than $1,000 in tax after all withholdings and credits are subtracted.
- You paid at least 90% of the current year’s taxes or all of the taxes owed for the year before, whichever is smaller.
- Your failure to make estimated payments were caused by unusual circumstances beyond your control, such as a casualty or disaster, making a penalty unfair.
- You retired after turning 62 or became disabled during the tax year when you were required to make estimated payments, and the underpayment was not intentional.
Underpaying your estimated taxes can lead to a significant tax debt, as you will continue to be charged interest until your obligation is paid in full. You are allowed to appeal the interest under certain conditions, such as evidence of mathematical errors, but it’s a complicated process that you should only undertake with help from an experienced tax attorney.
Speak with a New Jersey Tax Attorney
If you are dealing with estimated tax penalties that are unjustified and/or create a tax burden that you can’t afford to address in full, working with a tax lawyer can result in:
- The penalties being minimized or even waived
- Your tax debt being made more affordable by an offer in compromise or IRS payment plan.
Attorney Brad Paladini at Paladini Law holds a Master of Laws in Taxation and can advise you on whether your situation should be resolved by a payment arrangement, an appeal of the IRS assessment, or another form of relief. To schedule a consultation, please call 201-381-4472 or complete our online form.