Some Federal Employees, Retirees Should Be Aware of the Need to Pay Federal Estimated Taxes

Most federal employees, retirees, and annuitants receive some types of income that are not subject to mandatory Federal and state withholding taxes. Among these income-types are interest, dividend and capital gain income, retirement income and IRAs, CSRS and FERS annuities, rental income and Social Security. But it makes no difference as to the type of income or the source of the income, the IRS wants to collect the tax due on income as soon as the income is received. This column discusses why some federal employees and annuitants should make quarterly estimated tax payments to the IRS.

It is important to present some background information about estimated tax payments. The US tax system works on a “pay-as-you-earn-basis.” That is why employers withhold Federal and state income taxes, Social Security (FICA) and Medicare Part A (hospital insurance) taxes from employee salaries. The US Treasury’s goal is to collect on a regular basis the taxes due on taxable income not subject to withholding. This is done through estimated tax payments.

SEE ALSO:

• IRS Increases Penalty for Underpaying Estimated Taxes
• Have You Checked Your Tax Withholding This Year?

To accomplish this, the IRS has set up a timetable calling for estimated tax payments four times a year. Although the payments are commonly called “quarterly,” the payments do not coincide with calendar year quarters. The following table summarizes the “quarterly” income periods and due dates for the estimated tax payment for calendar year 2024.

The IRS recommends that individuals calculate the estimated tax liability amount for the entire calendar year, divide that amount by four and send in payments according to the schedule. There is a worksheet with the Form 1040-ES package or as part of most tax software packages such as Turbo Tax. The Form 1040-ES package can be downloaded by going here.

A paper check along with the Form 1040-ES payment voucher can be sent to the IRS Service Center each quarter. Alternatively, an individual can file electronically with a credit card by enrolling in the IRS’ Electronic Federal Tax Payment System (EFTPS), or by using the IRS’ Direct Pay option.

There are incidences in which individuals may receive a “financial windfall and will spend the proceeds without setting aside some of the proceeds to pay estimated taxes. For example, during 2023 the stock market had a good year. Stock and stock mutual fund investors were the recipients of dividends, short and long-term capital gain income. This taxable income was paid to investors throughout 2023. There are unfortunately many investors who did not give much thought to paying estimated taxes throughout 2023, resulting in a huge federal income tax balance due (more than $1,000) and a possible federal income tax withholding penalty when the 2023 federal income tax return is filed.

Ignoring one’s estimated tax responsibilities is not a wise tax move. In fact, if one owes more than $1,000 at the tax filing deadline (this year, April 15, 2024), the individual could owe added penalties and interest to the IRS, a result of federal income tax under withholding.

Determining Estimated Payments for 2024

The following are the steps for affected individuals to follow in determining how much to pay in Federal estimated tax payments during 2024. This procedure works even if an individual expects to owe substantially more in taxes during 2024 compared to what they owed during 2023. This is because the IRS considers that individuals are compliant when it comes to paying the required amount of federal income tax throughout the year (through payroll withholding and estimated tax payments) provided they pay either 90 percent of their current year (in this case, 2024) tax bill or a “safe harbor” payment based on either a 100 percent or 110 percent of the tax owed the previous year (in this case, 2023). The following are specific steps to determine how much an employee, or an annuitant, should pay in federal estimated taxes during 2024:

Step 1. Look at one’s 2023 Form 1040, line 24 (total tax for 2023). See below. For example, suppose the total tax for 2023 is $21,500.

Step 2. Subtract from the amount in Step 1 the amount one expects to have withheld in Federal income taxes from wages, pensions, the TSP, IRAs, etc. during 2024. For example, suppose that amount is $18,500.

Step 3. Subtract the amount in Step 2 from the amount in Step 1. That gives the individual the amount to be made up through estimated tax payments. Divided the result by 4 and that is the amount that the individual pays to the IRS each quarter. In this example, $21,500 less $18,500 is $3,000; $3,000/4 or $750 is therefore the amount of the estimated tax payment each quarter throughout 2024 in order to eliminate any possible withholding penalty during 2024.

The IRS’ safe harbor for income tax withholding and estimated tax payments refers to a regulation that eliminates an individual’s liability as long as the individual acted in good faith. In the case of income taxes, it is an amount that protects the individual from IRS penalties for income tax underpayment.

For higher income individuals – individuals with previous year’s adjusted gross income (AGI) of more than $150,000 for married couples filing jointly and single individuals, ($75,000 for married individuals filing separately) the “safe harbor” percentage is increased to 110 percent of the previous year’s total tax.

Finally, employees can avoid paying estimated tax payments by filling out and submitting an updated W4 withholding form to their payroll office in order to request additional withholding. CSRS and FERS annuitants can request from OPM Federal and state income tax withholding from their annuities. They may do so by going on their “services online” account with OPM. Social Security recipients can request Federal income tax withholding from their Social Security benefits. However, with 25 percent of calendar year 2024 having passed, some employees and annuitants may have to increase the amount of withholding by an additional 25 percent through the end of 2024.