I have an update to my April post. I was expecting a downturn for Q3 this year (which wound up not being the case thanks to the last few weeks pulling through), so I was playing around with what I thought would be my approximate Q3 income mid-quarter. Anyway, my previous calculation where I adjust the annual rate based on the cummulative quarterly income isn't a bad approach if your income is consistent, but if you have an off quarter, then it's actually a bad method because you wind up paying a lot more in taxes for that "bad" quarter than you need to. For example, if I only made $1,000 in Q3, I would owe around $1,683.00 using my previous method (assuming $20k for Q1 and Q2).
I spent a lot of time looking at different scenarios and found that it's just easier to set aside money at a set rate each quarter based on that quarter's income instead of trying to update my annual estimation each quarter. In my case, since I am on target to be in the 12% tax bracket (married filing jointly), the most conservative approach is to save 26.81% of my income and pay that each quarter. This covers the SE tax and income tax no matter what you make between $22,000 and $89,450 during 2023. My worst-case scenario would have me paying $332.20 over payment by the end of the year (assuming I only made $5,500 each quarter). Granted, I expect to get a portion of of my taxes back due to credits and deductions, but my goal is to not get dinged by the IRS for underpayment throughout the year.
The 26.81% rate comes from taking the highest income in the 12% bracket ($89,450) and dividing it by the total taxes due (SE + income). Other adjustments would need to me made, of course, if my income resulted in a different tax bracket. If I was making $20k during Q1, Q2, and Q3, but then made $100k in Q4, then I would obviously have to use a larger portion of that Q4 income to pay the higher tax rate for my new bracket. Also, if this was the case, I can only guess that the IRS would not penalize me for not paying a higher rate earlier in the year so long as I have documented throughtout the year and provide an appropriate rationale for my "estimation" each quarter.
Any thoughts or input from others, especially if your income varies significantly and/or you have changed brackets by year end?
