As every year draws to a close, you got one last opportunity to be sure you’re in Uncle Sam’s good graces when it comes time to settle up on your federal income taxes for the year. The IRS doesn’t expect you to know exactly how much you’ll owe before that April 15 day of reckoning. Still, you’re required to be paid up to an amount fairly close to your total tax due early enough in advance of that date. If you’re not, then you’ll likely find yourself subject to a penalty, on top of your taxes due.
The way to avoid that penalty is to be sure you’ve paid enough in a timely manner to be covered by at least one “safe harbor” rules. These are the guidelines that the IRS uses to determine whether you’ve paid enough and in a timely enough manner not to owe underpayment penalties.
How Much Is Enough, and When?
If, through with holdings and/or timely estimated tax payments, you’ve paid enough so that when you pay the remainder of your tax on or before April 15, you:
- Owe less than $1,000
- Paid at least 90 percent of the total you owe for 2013, or
- Paid at least 100 percent of the total you owed for 2012 (110 percent if you’re classified as a “high earner”)
…then you’re covered by the safe harbor rules and won’t owe underpayment penalties. (There are additional special rules for farmers and fishermen.)
For most people, it’s probably too late to start making estimated tax payments for 2013 to avoid the penalty, as estimated tax payments need to be made in a timely fashion. The IRS’ general rule on estimated tax payments is that, to be timely and avoid a penalty, the tax on money earned in:
- January through March needs to be paid by April 15 of that same year
- April through May needs to be paid by June 15 of that same year
- June through August needs to be paid by Sept. 15 of that same year, and
- September through December needs to be paid by Jan. 15 of the next year.
And yes, having the payment postmarked on that date counts as being timely.
Can You Still Avoid the Penalty?
Fortunately, all hope is not yet lost. If you get paid from an employer or have another source of income from which tax can be withheld, you have until Dec. 31, 2013, to pay enough through withholdings to be covered by safe harbor. Withdrawals from an IRA or payments from a pension, for instance, can have taxes withheld that count toward your safe harbor amounts.
For an ordinary wage earner, assume you ended up paying $3,000 in federal income taxes in 2012, on an income that didn’t classify you as a high earner. As long as you had at least $3,000 withheld for federal income taxes in 2013, you’re covered by safe harbor and don’t owe a penalty for 2013. That holds true even if you cashed in a stock or a mutual fund with a huge capital gain and will wind up owing the IRS thousands more on April 15, 2014.
If you still have a paycheck coming in 2013, you might still have time to adjust your withholdings at work to have enough withheld to be covered by a safe harbor rule. The form you’ll have to fill out and submit to your payroll department is called a W-4, and it’s available from the IRS at this link.
Whether or not you can get the withholding changed in time depends on how much lead time payroll needs before your payday to make the change. With only a few weeks left in the year, you’d better act fast. If the money isn’t withheld by Dec. 31, it won’t count for this year’s taxes.
So How Bad Is It?
If you’re already out of time and find yourself forced to pay a penalty, the sooner you make the payment, the less it will be. The penalty is based on interest rates and is determined based on how much you owe and how overdue that money is. Thanks to low overall interest rates at the moment, the penalty isn’t too bad right now, and it sits at 3 percent. If interest rates rise, though, that rate can move up for future quarters.
As low as it may be, that 3 percent penalty rate is more than you can earn on a safe short-term investment at the moment. Unless you actually feel the overwhelming urge to donate a little extra to the nation’s operational budget, you’d be happier getting your taxes and penalties settled as quickly as you can.