Is it possible to have an estimated tax payment penalty even if you got a refund? Yes, but you need to understand what’s going on.
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This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.
What’s the estimated tax penalty?
The estimated tax penalty is an IRS penalty that applies when you didn’t pay enough in estimated taxes. It is lower than the failure to pay penalty and is effectively an interest charge.
If you need to pay estimated taxes due to independent contractor income, investment income, or some other reason, you generally need to make four payments per year. Each payment should cover a quarter of your tax liability. If you don’t make enough estimated tax payments and owe more than $1,000 when you file your tax return, you may have to pay the penalty.
Here are the requirements to pay estimated taxes.
|Based on Current Year Tax Return||Based on Prior Year Tax Return|
|AGI up to $150,000 ($75,000 if married filing separate)||90% of current year taxes||100% of prior year taxes|
|AGI over $150,000 ($75,000 if married filing separate)||100% of current year taxes||110% of prior year taxes|
How can you owe a penalty if you’re getting a refund?
You can owe a penalty for underpaying estimated taxes even if you’re getting a refund for overpaying your taxes. It comes down to the timing of your payments. There are four quarterly payments, and each payment can have a penalty.
Here’s the language from the IRS instructions.
When a Penalty is Applied
In some cases, you may owe a penalty when you file your return. The penalty is imposed on each underpayment for the number of days it remains unpaid. A penalty may be applied if you didn’t pay enough estimated tax for the year or you didn’t make the payments on time or in the required amount. A penalty may apply even if you have an overpayment on your tax return.
The penalty may be waived under certain conditions. See the Instructions for Form 2210 for details.
Let’s say you need to pay $10,000 in taxes. Paying $2,500 in April, June, September, and January will cover that. If you skip the April payment and then pay $4,000 in June, September, and January, you’ve paid $12,000 in total when you only needed to pay $10,000. But, you still had late payments that can create a penalty.
- As of Quarter 1 (April), you paid $0 and you’re $2,500 late on your estimated taxes.
- As of Quarter 2 (June), your $4,000 payment goes towards the $2,500 you should have paid in April and $1,500 for the June payment. You’re still $1,000 behind.
- You catch up in Quarter 3 (September), because your $4,000 payment covers both the $1,000 you’re behind on and $2,500 for September. You’re now $500 ahead.
Even though you again paid more than you needed to in January, you still had late estimated tax payments in Quarters 1 and 2. For easy math (not exact numbers), I will call the penalty 1% per quarter (it varies with interest rates). 1% of the April late payment is $25, and 1% of the June late payment is $10. That’s $35 in penalties. So your tax refund amount is $12,000 in payments minus $10,000 in taxes owed minus $35 in estimated tax penalties. Instead of getting a $2,000 refund, you get $1,965 back.
Here’s the estimated tax calendar as a reminder.
|Action Needed||2021 Tax Year||2022 Tax Year|
|First Quarter Estimated Tax Payment Due||April 15, 2021||April 15, 2022|
|Second Quarter Estimated Tax Payment Due||June 15, 2021||June 15, 2022|
|Third Quarter Estimated Tax Payment Due||September 15, 2021||September 15, 2022|
|Fourth Quarter Estimated Tax Payment Due||January 15, 2022*||January 15, 2023*|
|Receive Your 1099||No later than January 31, 2022||No later than January 31, 2023|
|File Your Tax Return||Monday April 18, 2022 (due to Good Friday and Passover on the 15th)||Tuesday April 18, 2023 (15th is a Saturday; Monday is Washington, D.C., Emancipation Day)|
|Extended Filing Deadline||Monday October 17, 2022 (15th is a Saturday)||Monday October 16, 2023 (15th is a Sunday)|
Do you get interest if you paid too much earlier in the year?
In some cases, your estimated tax payments might be higher early in the year. You might have less income or more expenses than you were expecting, or you could just like to make larger payments early in the year to get your taxes out of the way.
Even though the IRS charges interest for paying late, it doesn’t pay interest for early payments. The only thing paying early lets you do is reduce your payments in the remaining quarters. For example, if you need to pay $10,000 in estimated taxes, you need to have paid:
- $2,500+ (25% of what you owe) by April 15th
- $5,000+ (50% of what you owe) by June 15th
- $7,500+ (75% of what you owe) by September 15th
- $10,000+ (100% of what you owe) by January 15th
It doesn’t matter if you pay evenly or pay more early. You can pay 100% in the first quarter and 0% for the rest of the year. You just need to have covered at least 25% each quarter.