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Safe Harbor and Estimated Taxes

One of the things that stressed me out about taxes this year (besides knowing that we’d owe) was knowing that I’d have to start making estimated tax payments next year. Fortunately, TaxCut helped me find a deduction for paying Micah’s tuition, which cut down on our taxes. And we came in under what’s called “safe harbor” so we didn’t owe the IRS anything for underpaying.

This year, we met the following safe harbor criteria:

  1. We had no tax liability in 2007 (last year’s taxes). As long as you don’t underpay two years in a row, you’re safe under safe harbor. This protects people who’ve made unexpected gains (like selling an investment) or have started out as freelancers. We won’t meet this criteria next year.
  2. Our underpayment was less than $1000. We didn’t need to meet a second criteria, but we did anyway. This one might actually get us under safe harbor next year, if we get the same tuition discount in addition to the extra money I’m having withheld at work.
  3. We had more than 100% of our 2007 (last year’s) tax liability withheld. (The number goes up to 110% if you make $150k/year or more.) This is similar to number 1, it allows for unexpected bumps in income.

As long as you meet even one of the safe harbor rules, you shouldn’t owe any penalties for underpayment (Federally). Since the IRS wants to get its money year-round (things just get evened-out at tax time), it wants to punish the people who keep them from getting money until the last minute. Safe harbor is designed to keep taxpayers from paying extra for honest mistakes/mis-estimates or flukes.

To be on the safe side for next year, I’m having extra withheld by modifying my W-4 to take money out of my paycheck for state and federal taxes each week. Since the Make Work Pay tax credit has upped my take-home pay, I should modify the W-4 again to have even more taken out. If it looks like it’s going to be too much, I can always bring it down again later in the year.

This should mean that we will at least meet the criteria of withholding more than 100% of our 2008 income. It should also mean that we’ll underpay by far less than $1000 even if my calculations are off.

The other option would be making quarterly estimated tax payments, which I’ve also considered doing. Since it’s more convenient to have the money taken out at work, I’m going to stick with that for now and base the withholdings on what I estimate my extra tax liability will be.

The fourth way we could have come in under safe harbor but didn’t, would have been by paying within 90% of our liability. The amount we owed was more than 10% of our total tax burden, but if we’d paid at least 90%, we could come under safe harbor. This is for people for whom $1000 is less than 10% of their taxes owed. If they owe more than $1000, but they’ve still paid 90% (e.g. they owe $50k and have paid over $45k) they’re still under safe harbor.

{ 1 comment }

Aryn April 14, 2009 at 1:50 pm

Another way around estimated payments (if the tax due at the end of the year is less than one or two paychecks), is to change your withholding in December to have your entire paycheck withheld. We’ve done this twice. They still get their money and you don’t have to report exactly when it was earned.

Aryn’s last blog post: The Dos and Don’ts of Combining Finances after the Wedding

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