The tax system is a pay-as-you-go system. That means there is a clear obligation, with penalties for non-compliance, to either pay your individual taxes during the year through either withholding from a paycheck or estimated tax payments. Here’s the rules:

  • There is no penalty if your taxes are paid through withholding and you owe less than $1,000 at the end of the year.
  • You can avoid the penalty if you pay at least 90% of current year taxes through withholding and evenly paid estimated tax payments OR
  • Pay 100% of the tax on the prior year tax return through withholding and evenly paid estimated tax payments OR
  • Pay installments on a current basis under an annualized method. This is for taxpayers whose earnings are irregular during the year.
  • HOWEVER, the 100%-of-prior-year’s-tax safe harbor becomes 110% if the taxpayers’ adjusted gross income exceeds $150,000.

For 2009 only, if a taxpayer derives over half their income from a small business and that amount is less than $500,000, the 100%-of-prior-year’s-tax safe harbor is reduced to 90% of prior year tax. Of course, the taxpayer still must be prepared to pay the remaining tax due on April 15 or substantial penalties apply.