If I use annualized installment for estimated taxes, is it true that on June 15 IRS wants 1/2 of projected yearly taxes with only 5 months of withholding?

[ivankrivyakov]

My income is part salary and part stock grants whose value is unpredictable. So, I use estimated payments with annualized income method. For the sake of argument, suppose that the employer withholds $5,000 each month and I owe another $3,000 for the stocks. For the first quarter it's easy, I pay $9,000 estimated tax. But for the second quarter IRS seems to want 6 months worth of tax against 5 months of withholding, so I need to pay $14,000 to avoid the underpayment penalty. This sounds super weird, but it seems to match the instructions. Am I missing something?

Now, what prevents me to ignore all that and make just one giant estimated payment on Jan 15? It is not hard to make sure it is over 90% I owe, so no underpaymen penalty. Is there a catch?

[NCperson]

no - look closely at the form; you are to estimate your income through MAY 31 - not June 30.

also that third payment due Sept 15, is for income estimate through Aug 31....

[ivankrivyakov]

It's not that simple, take another look.

First quarter: I am expected to pay the difference between 3 months worth of tax (x90%) and 3 months of withholding.

Second quarter: it's true that I take my income for 5 months up to May 31, then multiply it by 12/5 (2.4) - so far, so good. But then I am expected to pay the difference between 6 months worth of tax (x90%) and 5 month worth of withholding and estimated payments. This results in a much higher payment than in the first quarter if I partially rely on withholdings. 

[NCperson]

Form 2210 is what will eventually determine the penalty (if any).. have you placed your assumptions on that form? if so, "it is what it is".....those are the IRS rules. 

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

[ivankrivyakov]

I am asking the question precisely because I put my numbers in the worksheet 2-7 of publication 505 and in the form 2210, and they look weird.

Suppose you ended up receiving even income throughout the year (but you don't now that in advance). 
Your total tax for the year: $60,000.

Your tax each month: $5,000.

90% of this: $4,500 a month.

Employee withholds: $4,400 a month.
Additional estimated tax to avoid penalty: $100 a month.

Now, let's say you made a small mistake and your tax is actually $60,120. Let's check how the penalty is calculated.

Required installment each quarter (line 10 of form 2210): $13,530 

First quarter: you owe $13,530

Your estimated payment: $300

Employer withheld: $13,200

Total payments: $13,500

Underpayment: $30, expected, no big deal

Second quarter: you owe $13,530

Your estimated payment: $300

Employer withheld: $8,800

Total payments: $9,100

Underpayment: $4,430. Oops...

You would need to pay $4730 in the second quarter instead of $330 to avoid the underpayment penalty. This includes your usual pament plus missing one month of employer withholding.

Does my question makes sense now?

[NCperson]

look at check box "D" under Part II of Form 2210.......I think that accomodates your issue.....

from the instructions: 

Section A—Figure Your Underpayment
Line 10
Enter on line 10, columns (a) through (d), the amount of your required
installment for the due date shown in each column heading.
For most taxpayers, this is one-fourth of the required annual payment
shown on Part I, line 9.
However, it may be to your benefit to figure your required installments
by using the annualized income installment method. See the
Schedule AI Annualized Income Installment Method instructions, later.

then see page 8 of the instructions for Schedule AI

[Mike9241 · Accepted solution]

using the 2210 part III is where you compute the underpayment. read the instructions for line 11 especially the ability to use actual withholding rather than 25% of the total for the year. 

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

column b would be the estimates  and withholding paid 4/15-6/15

+ any overpayment from column a) line 18

the tax that must be paid through the second quarter is 45% of the annualized tax. from 2210 schedule AI line 20

the alternative assuming your AGI is over $150,000 in the prior year is to pay in   as follows

1st quarter by 4/15 (or the actual due date) 27.5% of the tax for the prior year reduced by actual withholding 1/1-4/15

2nd quarter by 6/15 (or the actual due date) cumulatively 55% of the tax for the prior year reduced by actual withholding for 1/1-6/15

 3rd quarter by 9/15 (or the actual due date) cumulatively 82.5% of the tax for the prior year reduced by actual withholding for 1/1-9/15

4th quarter by 1/15 of the following year (or the actual due date) cumulatively 110% of the tax for the prior year reduced by actual withholding for the year

notes: a) read the 2210 instructions for how to compute the prior year's tax. it may not be the same as line 24

b) rather than using actual withholding when you do the 2210 at year-end you can use 25% of the full year's withholding for each quarter but whichever method you use it must be used for all 4 quarters.

[Critter-3]

OR ... since payroll withholding is considered ratably withheld evenly thru the year you could simply increase your payroll withholding to cover the "safe harbor" amount needed ... then if you have a refund you can apply it to the next year's taxes.   

OR ...  simply pay an estimated payment for the quarter's you actually have taxable sales.

OR ... pay estimates using the safe harbor method already mentioned.

The actual 2210 is used at the end of the year to compute possible penalties and it not really meant for the calculation of the quarterly estimated payments so it is awkward to use. 

[Hal_Al]

Q. If I use annualized installment for estimated taxes, is it true that on June 15 IRS wants 1/2 of projected yearly taxes with only 5 months of withholding?

A.  No. You may use the annualized method to make your estimated payments. So, your 1st and 2nd quarterly payments can total less than half your tax for the year, as long as it covered the tax due on your income for the first 5 months.  TurboTax cannot do that. You will have to calculate the quarterly payments manually. Doing so will require you to prepare form 2210 when you file your 2022 tax return. 

Q. What prevents me to ignore all that and make just one giant estimated payment on Jan 15? It is not hard to make sure it is over 90% I owe, so no underpayment penalty. Is there a catch?

A. The real question is "are the IRS computers sophisticated enough to catch that?"  I don't know for sure, probably.  I do know that TurboTax is not that sophisticated. It will not calculate a penalty in that situation. 

Here is a gimmick that does work (if your employer will cooperate): increase your  late year withholding to cover the extra taxes.  The rule is that withholding is treated as paid evenly over the year, but estimates are only credited to the quarter actually paid. 

[ivankrivyakov]

Thank you. I did not realize IRS gives you an option to pretend 25% of yearly withholdings took place over each period. Funny that they call it "evenly distributed", because there is nothing even about it.

Of course, choosing this option would mean I would be in deep underpayment if I get fired in the second half of the year, but hopefully it would not happen.

[WCM65]

@Critter-3 That's not entirely accurate.  Worksheet 2-7 is expressly for estimating quarterly payments under the Annualized Income Installment Method.  Though there's no guarantee that the IRS won't ding you for a penalty for a quarterly underpayment even if you follow the procedures, as one of the steps is to estimate your full-year AGI.

[Mike9241]

no 45% 

look at form 2210 the AI schedule. this requires you to determine your actual taxable income for

1/1-3/31

1/1-5/31

1/1-8/31

1/1-12/31

you must also determine  your actual other taxes and tax credits for each period such as self-employment tax, alternative minimum tax, NIIT, additional Medicare tax, tax figured if you have qualified dividends and long-term capital gains  

for the first quarter 22.5% of the annualized full year tax due 4/18/2022

for the second 45% of the annualized full year tax due 6/15/2022

for the third 67.5% due 9/15/2022

for the 4th 90%  due 1/16/2023

[fanfare]

@Mike9241 you summarize the desired result succinctly,

the problem is separating out your actual income, interest, deductions, and capital gains into those time periods.

This is tedious and non-trivial.

Too much work for me.

Maybe a rich person could pay some accountant to do this.

But if you're rich you can just over-estimate your estimated taxes and be done with it.

[Critter-3]

This is why most folks use the safe harbor method of paying the estimated payments when possible since it uses a known amount ...

The following is the general rule:

You must pay estimated tax for 2021 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2021 after subtracting your withholding and tax credits.
2. You expect your withholding and tax credits to be less than the smaller of: 
   1. 90% of the tax to be shown on your 2021 tax return, or
   2. 100% of the tax shown on your 2020 tax return. Your 2020 tax return must cover all 12 months.

Note: If your AGI for 2020 was more than $150,000 ($75,000 if your filing status for 2021 is married filing a separate return), substitute 110% for 100% in (2b)

[Mike9241]

I agree it's a real pain for quarterly estimates until year-end and in some cases close to impossible but taxpayers that use Quicken, Quickbooks, Mint, or even Excel probably could do it except for the major problem with qualified dividends and other tax data they don't have like partnership, s-corp, trust income/lost until year-end. they do have the option of estimating where they don't have full info. but. but if they estimate low they get hit with the penalty after spending time do this every quarter.