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Underestimated Tax Payments

One of the items that I look at when I review an income tax return for our clients is whether the taxpayer was assessed an underpayment penalty. I have discovered that a lot of clients are not aware of how much these rates have increased and what they can do to reduce the penalty. Hopefully, the following will be helpful to you if you are subject to paying estimated income tax penalties.

 

First and foremost, remember that the payment of income taxes is a concept of “pay as you go” method. This refers to the system where taxpayers are required to pay their income taxes throughout the year as they earn income, rather than paying the entire amount owed at the end of the tax year.

 

The Internal Revenue Service imposes penalties for underpaying estimated income taxes throughout the year. These penalties, known as the “estimated tax penalty” or “underpayment penalty,” are calculated separately for each quarter based on the amount of unpaid tax for that period.

 

How the Penalty is Calculated:

The penalty equals the federal short-term interest rate (in the first month of the quarter in which taxes were not paid) plus 3 percent. As of mid-2024, the estimated tax penalty has reached a whopping 8% – the highest it has been since 2007. This penalty is not deductible, so the effective rate is even higher.

 

Avoiding the Penalty:

To avoid the underpayment penalty, individuals with an adjusted gross income (AGI) of $150,000 or less must pay by the due date of the tax return the lesser of:

  1. 90% of the current year’s tax liability (paid through withholdings or timely quarterly estimates)
  2. 100% of the previous year’s tax liability

 

For those with an AGI above $150,000, the threshold is higher at 110% of the previous year’s tax liability. These amounts can be paid through a combination of withholding from paychecks and timely quarterly estimated tax payments.

 

It’s important to note that meeting the safe harbor requirement (either 100% or 110% of the previous year’s tax liability) guarantees avoidance of underpayment penalties, regardless of your actual tax liability for the current year. However, if you expect your income to decrease, you may choose to pay 90% of your estimated current year tax liability instead, though this carries more risk of penalties if your estimate is too low

 

Safe Harbor Rules

The IRS provides “safe harbor” rules that allow taxpayers to avoid the penalty if certain conditions are met, such as:

  • Owing less than $1,000 in taxes (This is not after estimated or withheld taxes, it is the total tax owed)
  • Paying at least 90% of the current year’s tax liability through withholdings and timely estimated payments

 

Notice that taxes withheld from wages & other sources are treated as if they were withheld equally over the year.

    • Withholding a large amount from an IRA distribution towards the end of the year does gives you credit for tax payments as if you made them equally throughout the year.
    • When you take a taxable distribution from your traditional IRA, you have the option to have federal income tax withheld from the distribution amount. The default withholding rate is 10%, but you can elect to have a different percentage withheld using IRS Form W-4R. The withheld amount is credited against your total tax liability when you file your tax return for that year.
    • However, the timing of the withholding does not affect how the payment is credited. Whether you withhold the entire amount in December or spread it out evenly throughout the year, the total withheld will be treated the same way – as a prepayment towards your tax liability for that year. There is no advantage or credit given for making withholding payments earlier in the year.
    • The IRS does not consider when the withholding occurred – only the total amount withheld for the tax year. If too little tax is withheld compared to your actual tax liability, you may owe additional taxes plus potential underpayment penalties when you file your return.
    • So in summary, while withholding from an IRA distribution can help cover your tax liability, the timing of when that withholding occurs within the tax year is irrelevant. The total amount withheld is simply credited as a prepayment when you file, regardless of whether it was withheld upfront or at the last minute

 

 

Quarterly Payment Deadlines

For those required to make estimated tax payments (e.g., self-employed individuals, business owners), the quarterly deadlines are typically:

  • April 15
  • June 15
  • September 15
  • January 15

 

However, these dates may be adjusted if they fall on a weekend or holiday. By understanding the estimated tax penalty rules and making timely payments through withholding or estimated payments, taxpayers can minimize or eliminate this costly penalty.

 

One effective way to minimize or avoid the estimated tax penalty is to use the annualized income installment method. This method allows you to pay estimated taxes based on your actual income earned during each period of the year, rather than having to project your entire year’s income upfront.

 

The annualized income installment method divides the tax year into four payment periods, with each period using a different income annualization factor:

  1. Period 1 (Jan 1 – Mar 31): Annualize income for this period by multiplying by 4
  2. Period 2 (Jan 1 – May 31): Annualize by multiplying by 2.4
  3. Period 3 (Jan 1 – Aug 31): Annualize by multiplying by 1.5
  4. Period 4 (Jan 1 – Dec 31): No annualization needed for full year

 

By annualizing your income for each period based on the actual amounts earned, you can make more accurate estimated tax payments that reflect your cash flow. This reduces the likelihood of underpaying and being subject to penalties.

 

To use this method, you need to complete IRS Form 2210 (Underpayment of Estimated Tax by Individuals) and attach it to your tax return. Be sure to check Box C for “Annualized Income Installment Method” under Part I.

 

While the annualized method involves more calculations, it provides flexibility for those with fluctuating or seasonal incomes. It ensures you pay the proper estimated taxes based on what you’ve actually earned, rather than an upfront projection.

 

So, if your income varies significantly throughout the year, strongly consider using the annualized income installment method. It can save you from costly underpayment penalties by aligning your estimated tax payments with your actual earnings pattern.

 

If you have your tax return prepared by a tax practitioner, be sure to provide them with the information that they will need to use this method. They can determine the amounts from the sale of assets where they have the dates sold. However, for income that you receive a 1099 for, you will have to provide the dates received to them.

Article by:  Lewis Robinson, CPA

To further discuss this article, contact Lewis Robinson at LRobinson@capsouthpartners.com

To learn more about CapSouth and the services we provide, visit our website at capsouthwm.com/what-we-do/ or click here to schedule a Discovery Call.

Investment advisory services offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent Registered Investment Advisor. This material has been prepared for planning purposes only and is not intended as specific tax or legal advice. CapSouth Partners does not provide tax or legal advice. Please consult your tax or legal advisor prior to making decisions which may have tax or legal consequences. Information provided by sources deemed to be reliable.  CapSouth does not guarantee the accuracy or completeness of the information.

 

Now Hiring! Client Service Associate I (Institutional Clients)

CapSouth Wealth Management was founded in 2001 and provides financial and wealth management planning and investment advice to individuals, families, and companies across the southeast.  The right individual will embody our core values.  They will have extremely high integrity, accountability, and respect for others.  They will be driven to continuously improve and collaborate well with others.  We are a family first organization that embraces change and offers competitive pay, great benefits, and potential for growth.

  1. MISSION

A Client Service Associate provides client service support, retirement plan support, and investment management support, usually with other professionals on the team, and under the supervision and mentorship of a Wealth Advisor.  Most of the Client Service Associate’s time is spent scheduling meetings & requesting documentation, managing paperwork, prepping and following up on client and team meetings, maintaining the CRM, confirming follow-through on commitments, and other duties as necessary.

 

  1. ESSENTIAL RESPONSIBILITIES
  • Creates agendas, meeting notes/minutes, and assigns appropriate follow-up tasks to team members, as necessary.
  • Ensures Retirement Plan Committee and Participant Education meetings are scheduled, confirmed, and up to date.
  • Creates client service tasks/sequences and assigns out as needed.
  • Processes necessary paperwork and performs administrative tasks for onboarding and service.
  • Coordinates meetings, documentation, and follow-up with clients.
  • Coordinates with plan sponsors, retirement plan administrators, and retirement plan committees.
  • Attends Retirement Plan Committee Meetings (RPC), creates minutes, and provides client service support to all clients.
  • Creates and maintains client data/informational sheets and ongoing agendas for each client.
  • Brings relevant and timely information to internal team meetings.
  • Infrequently, CSA may attend and takes notes for employee education meetings and enrollment meetings as directed by the Lead Advisor (may require limited overnight travel).

 

III. POSITION SPECIFICATIONS

Growth Responsibilities:

  • Master software and procedures.
  • Be able to understand client and advisor expectations and create a process to meet them.
  • Having or actively pursuing a bachelor’s degree in a related field is preferred.
  • Working towards CRPS and/or Series 65 License.

 

Skills and Knowledge:

  • Self-starter.
  • Demonstrates analytical ability, good judgment, problem solving, responsibility, personal integrity, and able to maintain confidential information daily.
  • Reasonable knowledge of Human Resources Management, Benefits, Payroll, and/or 401k Plans.
  • Enjoys working in a team environment and ensuring assigned tasks are completed.
  • Excellent communication and listening skills.
  • Proven Verbal & written communication skills, along with client service & interpersonal skills.

 

Benefits include:

  • 401k plan with match, non-elective contribution, and potential for profit-sharing contributions
  • 5 annual holidays
  • Paid time off starting at 14 workdays the first year, increasing by one day annually, maxing out at 25 days per year (accrual rate based on hours worked so actual days may vary).
  • Great medical benefits (partially subsidized by the company), along with the option to add supplemental medical coverage, dental, vision, long-term disability, life, voluntary life, and other supplemental plans.

To apply, email resume and cover letter to karmstrong@capsouthpartners.com.  Cover letter required. 

The position description above contains representative examples of work that will be performed in positions allocated to this classification. It is not required that any position performs all the duties listed, so long as primary responsibilities are consistent with the work as described. Roles and responsibilities can often be expanded to accommodate changing business conditions and goals, as well as to tap into the skills and talents of the individuals in the company. Accordingly, associates may be asked to perform duties that are outside the specific functions that are listed.

 

Financial Lessons

Lessons For Any Season

When I was a kid, Roswell was but a small rural town about 25 miles north of Atlanta. Not at all the seamless expanse of Atlanta that it is today.  Life seemed to move at a much slower pace then. News didn’t travel as fast, divided highways weren’t even a thing, and kids still used words like “sir” and “ma’am”.  And there were consequences when those words weren’t used, as I can attest.  Both of my parents worked outside of the home, and I spent a good deal of my summer breaks at Grandmom and Pop’s house. Pop worked the majority of his career at Lockheed Martin assembling airplane engines as I recall. Upon retiring from Lockheed Martin, he continued working in his other responsibility – that of a farmer.  If it could be grown, they grew it. And if they grew it, they ate it. Every bit of it. Nothing went to waste.

Forty-five years ago this summer, I spent 24 hours with my grandparents that I’ll not soon forget. Nothing out of the ordinary and certainly not by today’s standards, anyway.  It was just your run of the mill stifling hot day in June. But on this day observations were made, lessons were learned, and the takeaway has never been forgotten. Some lessons may be learned the hard way, folks may say.  That is, from personal and painful experience. And then other lessons aren’t hard at all. They’re blessings, actually. (Maybe they’re both blessings. An article for another day, maybe.)   Both can be experiences that leave a mark and one you won’t soon forget. Financial lessons are no different in that regard. You learn them, you remember them, and you instill the virtue of a lesson learned with those you love.

In my tenure as an advisor working with clients and 401(k) participants, there’s a certain sensibility, and I’m speaking in generalities here, that my more seasoned (older) clients seem to live with than maybe my younger clients. That is, clients representing an older generation tend to appear more comfortable with financial pressures or realities? And why would that be? Is it merely the fact they made it through them?  Mmm…it goes deeper than that, I think. I’ve compiled a small list of common life and financial life lessons I’ve heard (and learned) from my elders:

 

  1. It’s better to go to bed wanting, than owing.  And of course we’re talking about debt. Did you know we’re currently at an all-time high in our country for consumer debt? The largest increase coming from – you guessed it – credit card debt1. And the irony is that particularly in times of higher inflation, you’re better served paying down debt, not increasing it. While your single dollar won’t buy nearly as much as it used to, that same single dollar will still pay off one single dollar of debt. My clients talk of the lack of patience or the need for instant gratification in some of their much younger family. A common response to a want or need from the younger generation if they don’t have the cash?  “I’ll just charge it.”  For many of our parents or grandparents, there was a time when instant gratification wasn’t even a thing.  Gratification was more about the receipt of the blessing rather than the timing of it.  With respect to what you’d like to have and what you’d like to have now, consider, it’s better to go to bed wanting than owing.
  2. It’s about When and How Much. Ruminating on regret may lead to helplessness, depression, low self-esteem and may create the perfect environment for anxiety. (Just ask me. I can tell you all about it.) The two most common financial regrets I’ve heard from folks in their later years:  I wish I’d saved more, and I wished I’d started earlier.  You may recall hearing the following from your elders when you were your children’s or grandchildren’s age, “You need to be saving your money.” (Side note: I said that twice yesterday to two different kids.) Why do you think older folks are always saying that?  Because they know the importance of being good stewards of their money, and more likely, they were young once.  Older folks were raised in a completely different world than my teenagers and young 20 somethings currently are. Our parents and great grandparents spoke from experience, from scars, or perhaps from the appreciation of making wise decisions. If you’re reading this article, it’s almost a guarantee that your elders didn’t take financial (or life) advice from an 18-year-old social media influencer peddling purses or fat-loss routines. (Don’t get me started.) As one client told me, “Have the discipline to start saving now for the life you want to live in the future. Your future self will thank you.”
  3. List for Living. In 2023, there was an article published by The Legacy Project: Lessons for Living from the Wisest Americans. Sweet Ms. Verna, 91, wrote a List for Living for her great grandchildren. I’m quite confident none of us reading this article have attained 91, so let us marinate on a few points of her wisdom, shall we?

a) So many things in the world have changed since the time of my grandparents and parents and the earlier times of my own life, and I know that there will be lots of changes in your lifetime too.

b) I hope you will be a positive thinker, not negative or cynical; look for the good in people and things, and fill your life with love, kindness, and thoughtfulness for others.

c) Most important is to know God as you go into the future. I would hope that you will know the peace and joy and courage that comes from following a life of love and service – the peace that passes all understanding.

d) Your real success in life lies is the kind of person you become, not with how famous or wealthy you are, so my most sincere wish is for you to live the wholesome life that will lead you to make good choices along the way… You can do it.

It stands to reason the period you grew up in has a lot to do with how you filter life experiences.  My grandparents were teenagers in the Roaring Twenties and were 20 somethings during the bleak years of the 30s. As many have learned – though it’s possible some reading this may have had little exposure to The Great Depression – the 30s were a decade of economic volatility, if not misery. The unemployment rate (defined as the percentage of people in the labor force who do not have a job but are actively looking for one) was in the mid-teens for nearly half the decade and in the low to mid 20s for the rest!  Without a doubt, my grandparents faced an economic reality that I can only imagine, but not fully appreciate.  But theirs was an experience they wanted their children and their grandchildren to learn from. And that brings us back to that hot day in June…

Pop said he needed my help in the garden and that I should spend the night with him and Grandmom. Sure! I get to stay up and watch the news, talk sports with Pop, eat home-made chocolate pie? The garden? Okay, whatever. I’m sure I was lukewarm to that part of the itinerary. What, throw a little dirt around? Look for crickets? Whatever, it’ll be fun. (Yeah, I know. I’m smirking as I type these words.) At 5:00 the next morning, he woke me up. He was already in his overalls, shaven, and with biscuits in the skillet. (skillet: n. a frying pan.) I stumbled into the kitchen to see Pop stirring the eggs in the other skillet that had just been used for the patty sausage. While I’m struggling to put the strawberry preserves on my biscuit, Pop was opening the screen door to the yard with his red handkerchief in his back pocket. We were in that garden for two hours and both nearly dying of thirst, exhaustion, and hunger. (smirking again) Pop hadn’t broken a sweat. His day had barely begun. And the only words he said to me up to that point were, “Pick the ones that are turning purple and put them in the bucket. When the bucket’s full, take them to your Grandmom.” “Yes sir!” was the expected and only acceptable response in the moment. Though, what I wanted to say was, “I can’t do this anymore. My back hurts. It’s too hot. When do we eat lunch? What time is it? What just bit me?! When is my mom coming to get me?” But alas, it was just me, Pop’s silence, and the unmistakable sound of cicadas in the June heat. Halfway into that bucket, Pop came up to me and said, “Why don’t you go to the porch up yonder and help your Grandmom snap peas.” “Yes sir!” was my enthusiastic reply. He knew. And I knew. I was not accustomed to this kind of work. The only kind of work that my grandfather knew. Hard work. Necessary work. Work to be grateful for. And he handled it like Pop would. With understanding, but only after the weight of the experience settled upon my sunbaked neck. (I’m being melodramatic you say? You get out there in the garden for two hours, then. You’ll see.  Now you’re smirking.)  A lesson from one generation to another. Providing can be difficult, uncertain, and uncomfortable. But it has to be done. And it’s a lesson that has to be passed down.

You’ve learned lessons along the way.

Which ones are you passing down to those coming up behind you?

On this day, a way of life was observed, and lessons were learned that have been passed down to my boys these many years later. And I’d give anything to see that red handkerchief in the garden again. I believe one day I will. And I’ll thank him for what he taught me that day.

To further discuss this article or to learn more about how CapSouth Wealth Management can help, click here to visit our website, or call 800.929.1001 to schedule an appointment to speak with an advisor.

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice.

  1. (Americans are Carrying Record Household Debt into 2024, Market Watch, Jan 24, 2024)

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