Sunday, August 12, 2007

Estimated Tax: Self-Employed

Trina asks:

I'm self-employed with a highly variable income. Last year I made a little money in the first quarter and second quarter and then more in the 3rd quarter with significantly more in the last quarter of the year. I paid estimated taxes in each quarter based on the income I had and assuming a pretty high tax rate. At the end of the year I got hit with a penalty for not paying my estimated taxes in 4 equal payments. I used Turbotax for my taxes. This year I'm on the same boat pretty much. Is there anything I can do to get out of the penalty? I have no way to guess my income for the year based on what I make in the first quarter and would not be able to pay enough in estimated taxes even if I could accurately predict the final result.


My reply:

Hello Trina, thanks for visiting.

Since you did not earn your income evenly throughout the year (like a W-2 wage earner typically does) and you calculated your estimated taxes based on the income you earned, your estimated tax payments were not the same each quarter. Assuming you calculated the taxes that you owed correctly each quarter, you utilized an acceptable method and most likely should not be subject to a penalty.

In order to inform the IRS that you used this method and that you calculated the amount you owed correctly each quarter you should have filed Form 2210 with it's schedule AI (Annualized Installments) along with your tax return. On that form, you show how your income was earned over the year and that your estimated tax payments matched that income.

If everything is done correctly (making the correct payments and completing the forms correctly), the IRS would not have assess a penalty.

My guess is that TurboTax has the ability to compute and print Form 2210, but I do not use TurboTax so I am not sure. If it does have this ability you may want to go back and try to print this form and send it to the IRS, but please be careful when completing this form as this can be a very complex calculation, as you have more than one option for computation. As I'm sure I said many times before it is usually in the best interest of sole proprietors (or anyone who has a business) to have a professional help them with their taxes. You may want a professional to help you
prepare the form correctly and respond to this notice.

For more information you may wish to review IRS Publication 505, Withholding and Estimated Tax.

Best wishes,

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