With the tax deadline rapidly approaching on May 17, I have had many calls from clients that are surprised that they owe taxes this year, and in come cases, they need to pay a penalty. What situations typically cause something like this to happen, when the feel like they have completed their W-4 form correctly with the right filing status and exemptions? In many cases, there can be a higher earning spouse with the other spouse earning much less. The lower earning spouse will have their withholding based only on their income, which results in a much lower tax withholding rate than what they would have paid as a couple considering both incomes. In other situations, someone has started their own business, and will be reporting their income on Schedule C. They have paid no tax throughout the year, resulting in income tax and self employment tax that is due when they file their taxes. In addition, I have clients that have received stock options that they have exercised and will be taxed on, or have received restricted stock units that are fully taxable when received and they have not withheld taxes. Some clients have sold investments or a home during the year and have a realized capital gain that will be recognized this year, but they have not filed estimated taxes to pay for the additional tax that will result from these transactions.
The IRS says that you need to pay quarterly estimated taxes if you expect:
- You will owe at least $1,000 in federal income taxes this year even after your withholding and refundable tax credit and
- Your withholding and refundable credits will cover less than 90% of your tax liability for this year or 100% of your tax liability last year, whichever is lower. The threshold is 110% if your adjusted gross income last year was more than $150,000 for married couples filing jointly.
Self employed individuals or independent contractors have not had taxes withheld from their income, and they are prime examples of people that probably need to file estimated taxes
Clients with rental income or investment income often need to file estimated taxes, since their withholding does not take these items into account. Estimated quarterly tax payments are due as follows:
If income was earned from Jan 1-Mar 31 2021, the estimated taxes were due April 15, 2021. If income was earned between April 1-May 31, the estimated taxes will be due on July 15. The estimated taxes for the next two quarters are due on September 15 and January 15, 2022, respectively.
The IRS will charge penalties if you did not pay enough tax throughout the year. They can charge you a penalty even if you are due a refund when you file your tax refund. To make this easier, some people just adjust their withholding with their employer to cover the additional taxes they think they will owe. This can be accomplished by completing a new Form W-4.
It is a great time to consult with your tax preparer or financial advisor to determine if your withholdings should be changed at the federal and state level, and also to see if you might need to file estimated taxes.
About the Author
Patti Hughes is a Chicago Fee-Only Financial Planner. Lake Life Wealth Advisory Group provides comprehensive and objective financial planning, retirement planning, and investment management to help clients organize, grow and protect their assets through life’s transitions. She is a fiduciary, and does not sell products or earn commissions, so she truly acts in the best interests of her clients.