Safe harbor rules allow you to avoid estimated tax penalties

The April 15 deadline for filing tax returns is well known. But paying taxes is actually a year-round proposition. For example, employees are required to pay tax through regular withholding payments, while others must make quarterly installments of estimated tax. Fortunately, a change in the new tax law eases the requirements for certain taxpayers.

Basic rules: An individual is required to pay estimated tax unless he or she owes $1,000 or less in annual tax (after subtracting tax withheld from salary) or had zero tax liability in the prior year. The quarterly due dates are April 15, June 15 and September 15 of the current year, and January 15 of the next year. The deadline is moved to the next business day if the due date falls on a Saturday, Sunday or a legal holiday.

If taxes are not paid in a timely fashion, the individual is liable for an underpayment penalty, in addition to the regular tax owed. The interest rate for underpayments is announced by the IRS on a quarterly basis. For instance, the interest rate is 4% for the second quarter of 2009.

However, an individual may avoid an estimated tax penalty by qualifying under one of the following three safe-harbor rules:

1. No penalty is imposed if the amount paid for the current year is equal to at least 90% of the taxpayer's current tax liability.

2. No penalty is imposed if the amount paid for the current year comes to 100% of the taxpayer's tax liability for the prior year. The percentage for this safe harbor is 110% if the taxpayer's adjusted gross income (AGI) for the prior year exceeded $150,000.

3. No penalty is imposed if the amount paid for the current year comes to 90% of the tax that is due on the taxpayer's "annualized income." This safe harbor, which may apply to a self-employed individual with a seasonal business, requires additional calculations. A professional tax adviser can provide guidance.

It is usually easiest to qualify under the second safe harbor. For example, suppose an individual with an annual AGI of $100,000 owed $20,000 in tax in 2008. If the individual arranges to pay at least $20,000 in estimated tax for 2009, he or she will not be assessed any penalty. Conversely, payment based on 90% of current tax liability is harder to ascertain.

The new economic stimulus law creates a special tax break beginning in 2009. If an individual's AGI is less than $500,000 and more than 50% of the previous year's income came from small business activities, payments may be based on 90% of his or her previous year's tax liability (instead of the usual 100% figure). A "small business" is defined as a business with an average number of 500 employees or fewer. This new law change is expected to benefit many self-employed individuals this year.

Finally, the estimated tax penalty may be waived if the taxpayer can show that the underpayment is due to a casualty or some other unforeseen circumstance. In this case, be sure to retain relevant records, such as police reports and insurance company reports, as proof.

Talk to your trusted advisor to make sure that you're in compliance with the rules. Contact us - we can help.

mshulman@daszkalbolton.com or by phone at 561.953.1515.Michelle B. Shulman, CPA is a Senior Manager in the Tax Services Department and is based in our Boca Raton office. Michelle helps business owners make sound, tax-efficient decisions to keep them on track for the future growth and success of their companies. With a thorough understanding of owner-operated businesses, Michelle also serves as a liaison for financial planning and investment advisory services to ensure that owners have the best possible financial foundation for ongoing operations and, eventually, a secure retirement. Contact her at