Stay on top of estimated tax payments and avoid IRS penalties

June 15 was an important day for self-employed real estate professionals: It was the due date for the second estimated tax payment for 2011.

If you forgot about it, you can still pay it. The earlier you do so the smaller will be any interest or penalties you’ll owe on your late payment.

It’s important to remember that self-employed people must pay their income and Social Security and Medicare taxes themselves.

Nothing is withheld from their pay. Ordinarily, this is done by making four annual estimated tax payments to the IRS each year as shown in this chart:

Don’t get confused by the fact that the January 15 payment is the fourth estimated tax payment for the previous year, not the first payment for the current year. The April 15 payment is the first payment for the current year.

You must pay estimated taxes if you expect to owe at least $1,000 in federal tax for the year. However, if you paid no taxes last year-for example, because your business made no profit or you weren’t working-you don’t have to pay any estimated tax this year no matter what your tax tally for the year. You also don’t have to pay estimated tax if you have an employee job and the amount withheld from your pay by your employer will amount to at least 90 percent of the total tax you’ll have to pay for the year.

Paying estimated tax can be tricky because it requires you to estimate what your income for the year will be. This can be particularly difficult for real estate professionals who earn commission income that can vary substantially from year to year. If you don’t pay enough estimated tax, the IRS will impose a penalty.

Fortunately, there is a way to avoid having to estimate how much you’ll make this year. No matter what your income for the current year turns out to be, you won’t have to pay any penalties if the estimated tax you pay is at least the smaller of:  

• 90 percent of your total tax due for the current year, or
• 100 percent of the tax you paid the previous year or 110% if you’re a high-income taxpayer (those with adjusted gross incomes of more than $150,000 or $75,000 for married couples filing separate returns).

 For 2011 only, the Social Security tax self-employed people must pay has been reduced from 12.4% to 10.4% up to the Social Security earnings ceiling of $106,800. In other words, your Social Security payments will go down by 2%. This will reduce your tax burden for 2011 and is something you should factor into your estimated tax payments. The IRS has created a special worksheet you can use to figure this out. It’s included in IRS Form 1040-ES, the form you use to pay estimated tax.

Paying estimated tax is easy: you can do it by check, electronic funds withdrawal, or even by credit card.

The IRS imposes a money penalty if you underpay your estimated taxes. Fortunately, the penalty is not very onerous. You have to pay the taxes due plus a percentage penalty for each day your estimated tax payments were unpaid. The percentage is set by the IRS each year. The penalty has ranged between 4% and 6% in recent years. This is the mildest of all IRS interest penalties.

Because the penalty is figured separately for each payment period, you can’t avoid having to pay it by increasing the amount of a later payment. For example, you can’t avoid a penalty by doubling your June 15 payment to make up for failing to make your April 15 payment. If you miss a payment, the IRS suggests that you divide the amount equally among your remaining payments for the year. But this won’t avoid a penalty on payments you missed or underpaid.

Since the penalty must be paid for each day your estimated taxes remain unpaid, you’ll have to pay more if you miss a payment early in the tax year rather than later. For this reason, try to pay your first three estimated tax payments on time. You can let the fourth payment (due on January 15) go. The penalty you’ll have to pay for missing this payment will likely be very small.

For more details on estimated taxes, refer to IRS Publication 505, Tax Withholding and Estimated Tax. You can download it from the IRS website at www.irs.gov.