Most people pay their taxes to the Internal Revenue Service during the course of the year when withholding taxes are deducted from their salaries by employers. Suppose you have income that is not subject to withholding tax: interest, dividends, capital gains, pensions, self-employment wages, partnership income, etc. It may very likely be necessary for you to make estimated tax payments.

The tax rules require that in most instances this tax must be paid in quarterly installments during the year, rather than paid in a lump sum by April 15^th of the following year when you file your tax return.

However, not everyone who has dividend income or who has realized capital gains, for example, must pay estimated tax. How do you know when you must file? If you expect to owe at least $500 in tax after subtracting your withholding and tax credits and you expect your withholding to be less than 90% of the tax shown on your tax return or less than 100% of the tax shown on your prior year’s return, you are required to pay estimated tax.

For example, assume that an individual’s current tax bill will work out to be $10,000, and $9,100 had been withheld from his salary by payroll deduction for income taxes. The amount of additional tax owed on April 15^th of the following year will be $900. Even though that person owed more than $500 of additional tax, he was not required to file for estimated taxes because his withholding was at least 90% of his current year tax (90% of $10,000 is $9,000).

How would an individual know if he or she expects to owe at least $500 in tax? The answer is that you must prepare a tax projection that includes your earned and non-earned income and deductions. Many new rules took effect over the last 20 years, particularly for items such as interest expense, deductibility of individual retirement account payments and the repeal of the 60% exclusion for capital gains. In addition, the tax rates have changed. If you have considerable income from investments, it is important to retain professional advice.

Estimated taxes are due in four equal installments. For instance, if you owe $1,000 of estimated tax, you would pay $250 on April 15^th, June 15^th, September 15^th and January 15^th. Be certain to note that these dates are not spaced evenly. There are two months between April and June filings and four months between September and January.

You can also adjust your W-4 form so that enough is withheld by the end of the year to equal your anticipated tax liability.

Payments are to be made with IRS Form 1040-ES vouchers.

A non-deductible penalty is charged for failure to make estimated tax payments as required. The penalty must be paid at the time your tax return is filed. The penalty is computed at the underpayment rate established by the IRS. Although the computations are somewhat complicated, Form 2210 (underpayments of estimated tax by individuals) provides directions. The penalty has varied between 9% and 10%.

No penalty for underpayment of estimated tax will be imposed if your tax, minus withholding and credits, is less than $500, provided you have paid in at least 90% of your tax in four equal installments of 22.5% each, or you have paid in an amount equal to your tax. The IRS does waive some penalties but only under extreme and unusual circumstances.

Currently taxpayers may pay either 100% of their last year’s tax or 90% of the current tax. However, those taxpayers whose AGI exceeds $150,000 in the prior year must now pay either 110% of their last year’s tax or 90% of the current tax.

In July of 1992, Congress enacted a provision to require a withholding of 20% of distributions from qualified retirement plans, such as profit sharing, pension, 401K plans, etc. This measure was tacked on to the Unemployment Compensation Act as a funding method. The bill provided a waiver, however for a transfer directly to another qualified plan, such as an IRA.

There has already been two bills (HR 5745 and HR 5790) introduced to repeal this provision. However, in the meanwhile it would be advisable not to take constructive receipt of plan distributions, but to have them sent directly to an IRA account.