Estimated quarterly tax payments: questions about amount and frequency

[sfvoyage]

I understand that, to avoid potential underpayment penalties, I must pay at least 90% of tax owed for current year or 100% (or 110% for AGI threshold of $150K+) of prior year's tax owed.

TurboTax automatically calculates the 4 quarterly estimated tax payments for me based on the above.

My situation is that I am retired and have only investment income, whose stream does not come in evenly over the year.  My estimate is that, instead of 25% per quarter, it is around 20% for each of the first 3 quarters and 40% for the last quarter (due to the capital gain distributions from mutual funds at the end of each December).

My first question:  I can change the quarterly estimated tax payment amounts preprinted by TurboTax to more closely fit my actual income stream throughout the year.  As long as the total paid for the year satisfies the minimum amount for the year as per the IRS requirements (from the first paragraph above), I should not be subject to underpayment penalty (or interest penalties).  Is that correct?

A related question:  In general, does the IRS (and state of California) only care that you pay the entire amount for the year by the 4th tax payment due date?  Or does it actually look at your income stream during the year to figure out a quarterly amount?  I don't think the latter is possible because the IRS does not have data of my income on a monthly basis.

My second question:  In addition to paying quarterly, can I make 1 or 2 extra monthly payments per quarter?  For example, if I am supposed to pay $30k in June for the 2nd payment, can I pay $10k in June and $20k in July?  In other words, once I have determined my total estimated payment amount for the year, can I make my own payment schedule, for instance, 10 monthly payments that add up to the total amount due for the year?

[dmertz]

Regarding the first question, if you adjust your estimated tax payments as you describe, to avoid an underpayment penalty for the earlier quarters you'll need to annualize income on Schedule AI of Form 2210, an onerous task.  Unless interest rates rise substantially, it's generally not worth the effort to do this instead of just paying 25% each quarter.  However, if you track your income throughout the year, in anticipation of preparing Schedule AI, it might not be so bad.  Still, the amount of time you spend on that could easily result in a doubling of the effort needed to prepare your tax return.

The tax system is pay as you go, so underpayment is determined quarterly.  The tax code treats your income as received uniformly throughout the year unless you show otherwise on Schedule AI.  I imagine that California does similarly.

Regarding the second question, if you pay part of your required (based on the particular method of calculation that applies) Q2 estimated taxes in July instead of by the June 15 deadline, they will be late (absent any change in the deadline as we have seen in recent years) and the penalty will be determined by the number of days that the payment is late.  The calculations are done quarterly, not monthly.  See Form 2210 and its Schedule AI for details.

[sfvoyage]

Thanks for your reply.  To make sure I understand correctly, let's take a look at a couple of examples.

Assume that my estimated quarterly payment is 25k ( x 4 = 100k for the year) for all below scenarios.

Scenario 1:  I paid 20k per quarter for first 3 quarters, plus 40k for Q4, and my total tax due is 100k for the year.   Will the IRS still assess an underpayment tax penalty because I did not pay 25k per quarter, even though the total payment for the full year is 100K?  Or will they assess me interest penalties (but not an underpayment penalty)?

Scenario 2:  I paid 20k per quarter for all 4 quarters, and my total tax due is 80k (less than the estimated 100k).  Will I owe any underpayment tax penalty or interest penalties?

Scenario 3:  I paid 20k + 10k + 20k + 30k =80k for the 4 quarterly payments, and my total tax due is 80k (less than the estimated 100k).  Will I owe any underpayment or interest penalties (because I only paid 10k in Q2, which is less than 80k/4 = 20k)?

[VolvoGirl]

Here, check out form 2210 to figure any penalty 

IRS form 2210

https://www.irs.gov/pub/irs-pdf/f2210.pdf

2210 Instructions

https://www.irs.gov/pub/irs-pdf/i2210.pdf

[dmertz · Accepted solution]

I'll assume that your previous year's tax liability was $100k or more.

Scenario 1:  If you don't file Schedule AI of Form 2210, you will have underpayment penalties for the first 3 quarters because 90% of $100k / 4 means a required quarterly payment of $22,500.  If you file Schedule AI showing that your quarterly payments were sufficient to cover the tax liability was only $20k for each the first three quarters because the income was lower in those quarters than in Q4, you won't have underpayment penalties.

Scenario 2:  No penalty because your required quarterly payments are 90% of $80k / 4 =  $18k.

Scenario 3:  In the absence of filing Schedule AI your Q1 payment is sufficient ($20k is more than the $18k required) but you'll have a $6k underpayment for Q2 and a $4k underpayment for Q3.

[sfvoyage]

Thank you very much for your detailed reply to my 3 scenarios, which helped me understand the underlying concept.

Last year I owed a lot more (more than 2x) taxes than I normally do because of an unexpected huge capital gain distribution in late December from a mutual fund, which I have since sold.  As a result, TurboTax generated estimated quarterly tax payment amounts that are much higher than necessary for this tax year.

I am now confident that I can recalculate my quarterly payments without owing any underpayment or interest penalty.  Thanks again.

[sfvoyage · Accepted solution]

One more question, just to be sure.

If I determine that I have paid enough taxes (at least 90%) for the full year with my Q1 & Q2 estimated payments, am I correct that I can skip the Q3 payment and pay the remaining 10% or so with the Q4 payment, without incurring any penalties?

I think the answer is yes, based on your reply to my Scenario 3 above.  Thanks again! 

[dmertz]

If your Q1 and Q2 estimated tax payments total at least 90% of your ultimate current-year tax liability, there is no need to make any more estimated tax payments for the current year.  The final 10% of your tax liability would be due by the regular filing deadline for that year's tax return to avoid a late payment penalty.