Quarterly estimated tax?
August 17, 2006 7:03 PM   Subscribe

Recently laid off self-employed partner: should I send September's Quarterly Estimated Tax payment or keep it to buy food for my children?

My partner has been working full-time for the last six months as a contractor in a position that we expected to be long-term. Since the employer hasn't taken withholding, we've been doing estimated quarterly tax payments.

Alas, partner was laid off yesterday. A quarterly tax payment is due in September, and I have the money for it set aside. But I am wondering whether I can skip it. Here are some relevant points:

  1. We have already paid enough tax this year to avoid penalties for underpayment; we have already paid well more than 100% of last year's federal tax liability.
  2. I recently realized that when I was calculating how much estimated tax to pay, I forgot some deductions. So it's possible that we have overpaid and will get a refund. Overpayment seems especially possible now since I calculated based on the assumption that he would be in this job at least through the end of the year, and now his income for 2006 is likely to be much less than I anticipated.
  3. I think it is most likely that he will find regular employment with withholding rather than another 1099 job. But I haven't completely thought through how that might affect our total tax liability; it depends some on how much he earns at this new job which he will find soon.
If we could hold onto the several thousand I have set aside, it would nicely supplement our emergency savings for the (hopefully brief but we must plan for the worst) period of no income we are facing. I am assuming that even if we end up owing tax come April, next April is likely to be a much more convenient time to send off a big check that while our main source of income has fizzled out.

My question is whether there are any penalities associated with failing to send a quarterly tax payment after having sent the two previous ones, separate from any penalty for underpayment, which is not an issue in our situation.

posted by not that girl to Work & Money (11 answers total) 1 user marked this as a favorite
If you have already paid 100% of last year's taxes, then you have reached the safe harbor in which you will not owe a penalty for underpayment of estimated taxes. So you don't need to pay more estimated taxes. You are not required to send in a payent every quarter. However, make sure that you have enough money set aside to meet your remaining tax obligations in April.
posted by JackFlash at 7:34 PM on August 17, 2006

I believe the safe harbor is now either 110% or 115% of last years taxes, but either way (100, 100, 115) I would use the money for food. Spend it on essentials, but not on non-essentials. If you owe in April and have no $ to pay, the IRS will work out a payment schedule.

There is no penalty for meeting the safe harbor early. If you had waited until the fourth quarter to make a full safe harbor payment, you could be subject to penalty. In your case no.

By not paying, if you owe after meeting the safe harbor, you are simply taking out a high priced loan. You clearly are not subject to penalty, only the IRS usury rate.
posted by JohnnyGunn at 8:59 PM on August 17, 2006

Sounds like you are fine to me too. I thought the safe harbor was 90% of the current year or 100% of last year whichever is lowest. If partner starts working as self employed again you can re-start up with the payments then.
posted by pointilist at 9:33 PM on August 17, 2006

Keep it. I'm not a tax person, but have 12 years of contracting experience, and I've never heard of anyone getting penalized for their quarterly payments. All the IRS cares about is the amount at the end of the year. (Or April 15).

Quarterly payments (Just like regular employee withholding) are just for planing and not any kind of legally binding contract or promise. You could skip your payments all year and long as you pay what you owe on you 1040.

Of course try to keep some extra on hand come tax time, just in case.

Some related trivia: The IRS can be held at bay longer than credit cards and other obligations, but bankruptcy will not wipe out any liability to the IRS.
posted by Ookseer at 1:23 AM on August 18, 2006

When I was a freelance graphic designer, every year (for 3 years) I would say I was going to make quarterlies, and I never did. I also never was assessed any penalties as long as I paid my taxes on time.
posted by miss tea at 4:24 AM on August 18, 2006

You have all confirmed what I thought I understood from my reading; I'm going to hold onto the set-aside tax money for now as an extra buffer against starvation, but I think that even without it our emergency savings are likely to be more than sufficient to see us through this little crisis. We should be good as long as this isn't an extended (5+ month) period of unemployment, which seems vanishingly unlikely. I just wish I could get my lizard brain to believe that. It's kicking out stress hormones like we're about to be eaten by saber-tooth tigers.

Thanks, everybody.
posted by not that girl at 7:14 AM on August 18, 2006

Quarterly payments (Just like regular employee withholding) are just for planing and not any kind of legally binding contract or promise. You could skip your payments all year and long as you pay what you owe on you 1040.

I would be wary of this advice. It is incorrect. Quarterly and employee withholding are absolutely required. Maybe this person has never been caught, but it could cost you a big penalty if you don't pay required quarterly payments -- 10% plus interest for the delayed payment.

The simplest thing to do is to pay one-fourth of your previous year's taxes each quarter. If your income is less than the previous year, the IRS has a worksheet that you can use to estimate taxes and reduce your payments. On the other hand, if you over pay, once your payments exceed the previous year's taxes, you no longer need to make quarterly payments.

The idea that these are just a convenience for planning is wrong. They are required by tax law. The government demands its money early and often.
posted by JackFlash at 8:43 AM on August 18, 2006

I believe the safe harbor is now either 110% or 115% of last years taxes

From Pub 505:

If your adjusted gross income (AGI) for 2005 was more than $150,000 ($75,000 if your filing status for 2006 is married filing a separate return), substitute 110% for 100% in (2b) under General Rule, earlier. This rule does not apply to farmers and fishermen.

For reference, the General Rule is the one that states you have to pay the smaller of 90% of this year or 100% of last year. You're substituting the 110 for the 100. Note that you can also get out of paying the penalty with the Annualized Income Method if your income changes during the year.

But yeah, if you've paid enough, it seems like you should use the money to get by and avoid credit card debt. As was said, paying a certain amount 1 quarter does not obligate you to pay the same in future quarters. What you pay when only matters, as far as I can tell, if you 1. Underpay or 2. Pay the right amount but pay late. You may say, "aren't I paying late if I don't send something in this quarter?" but since you state that you've already paid more than last year, in terms of computing a penalty, it's more like you've paid your Sept and Jan payments early, since IIRC on the penalty form, payments in excess of your total minimum payment for the year divided by 4 are carried forward to your next quarter's payments. (My tax software had me pay like a $1 penalty last year because of some investment income I didn't account for in computing my estimated payments.)

I guess the one issue, as others have stated, is whether you will be able to make pay what you owe for this quarter's earnings once 4/15 rolls around. Without knowing anything about you or your situation, it seems like a good bet that your partner will find more work soon/you'll be able to save a little extra in the coming months if you do have to burn through some savings due to, heaven forbid, prolonged unemployment. If not, then I guess the question would be whether the IRS's finance charges or your credit card's finance charges would be higher.
posted by epugachev at 9:25 AM on August 18, 2006

JackFlash, you might be right, I'll ask my tax woman next time I have her on the phone. However I have been audited for years when I didn't pay quarterlies and there was no complaint. (But again, I'm not a tax professional If you're concerned, it's probably worth spending the $100 on one.). Also, quarterlies and withholding are estimates of taxes owed based on what you know about your taxes. If your situation changes, you are free to make changes to what you pay (withhold), so make adjustments as your income warrants. The IRS won't have documentation on how much you earned until your employer files the 1099 next Feb. (Assuming they do.)
posted by Ookseer at 9:29 AM on August 18, 2006

Also, quarterlies and withholding are estimates of taxes owed based on what you know about your taxes. If your situation changes, you are free to make changes to what you pay (withhold), so make adjustments as your income warrants.

Yep, this is true, but AFAIK this is not the same as their not being obligatory. The IRS may not know anything about what you should have paid until the next year, but that doesn't stop them from using their 20/20 hindsight to say, "well, since you earned X, you owed Y, and thus you should have paid Y/4 each quarter." Basically, they offer you the choice of using the certainty of the past (100 or 110%) or the uncertainty of the future (90%) to decide how much you are going to pay. If your rely on the future and you are wrong, you can be penalized.
posted by epugachev at 9:36 AM on August 18, 2006

Ookseer--is all your income 1099, or is some of it W-2? If enough is W-2, then that could eliminate the need for estimated payments?

That's really surprising that you don't pay estimated and they didn't care during an audit. I've always read the tax pubs as being pretty clear about estimated payments being required, and IIRC on the 1040 it says "if the amount you still owe us is greater than such-and-such line, then we're going to charge you a penalty."
posted by epugachev at 9:50 AM on August 18, 2006

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