In this article, we will go over different safe harbor rules and use examples to make them more understandable.
Example One:
Valerie is anticipating paying $450 in taxes because of the withheld amounts from her employer. To prevent underpayment penalties, what safe harbor rule should Valerie use?
If any taxes are due, they are less than the threshold amount. Penalties won't be applied to taxpayers who owe less than $1,000 in tax after subtracting any withholdings or credits. Valerie anticipates having to pay $450 in taxes.
Example Two:
Bobby's pay is subject to taxes because he works for two employers. According to Bobby, he will have to pay $12,000 in taxes through withholding. In the previous year, Bobby paid $11,000 in taxes and is anticipating paying $14,000 in taxes this year.
Paid at least 100% of the tax from the previous year. To avoid underpayment penalties, Bobby should be sure to pay the lesser of 90% of the current year’s tax [$12,600 ($14,000 × 90%)] or 100% of the prior-year tax of $11,000. Bobby met the safe harbor requirement by paying a minimum of 100% of the prior-year tax, which he did through tax withholding.
Example Three:
Based on the information provided, Janice made estimated quarterly tax payments of $11,000 for the current year. Additional information:
The current year's AGI is $180,000, and there is a $50,000 tax obligation.
The prior year's AGI was $160,000, but the tax owed was $40,000
Paid a minimum of 110% of the tax paid in the previous year. Because Janice’s AGI is greater than $150,000, to avoid underpayment penalties, she can utilize the safe harbor rule for payments, in which she must pay a minimum of 110% of prior-year tax. Janice met the safe harbor rules by making $44,000 ($11,000 × 4) in estimated tax payments, which is 110% ($44,000 ÷ $40,000) of the prior-year tax.
Example Four:
In the current year, Amber's unearned income is $2,600 and she is dependent. No taxes have been paid by her.
The threshold amount is not exceeded by any taxes owed. For tax year 2024, a dependent child’s gross unearned income over $2,600, but not to exceed the child’s taxable income, is net unearned income and is taxed at the parents’ marginal tax rate. The child's tax rate is lower than the parents' rate for any taxable income above the net unearned income. The parents' marginal tax rate will not apply to any of Amber's unearned income in this situation. Amber will be charged tax on $1,300 at the child's rate after her standard deduction of $1,300. Because Amber’s tax of $130 ($1,300 × 10%) is below the $1,000 threshold, there will be no penalties.
Example Five:
Steve, who is enrolled in college, did not owe any taxes in the previous year. This year, Steve only worked for 6 months and earned $28,800. Steve is a single individual and receives the standard deduction of $14,600. The 10% tax bracket is imposed on him due to his wages. Steve has contributed $1,300 to his current year taxes through withholding.
Paid at least 90% of the current-year tax. After the standard deduction of $14,600, Steve’s earned income is $14,200 ($28,800 – $14,600). Tax on the earned income is $1,420 ($14,200 × 10%). Because Steve had no income in the prior tax year, to avoid underpayment penalties, he must pay 90% of the current-year tax of $1,278 ($1,420 × 90%) through withholding or estimated tax payments. By withholding, Steve paid $1,300 toward his current year taxes and complied with the safe harbor rules.
Example Six:
Irene paid $2,500 in estimated tax payments on a quarterly basis. According to her estimation, she has accumulated a debt of $9,800.
Paid at least 90% of the taxes for the current year. According to estimates, Irene paid $10,000 ($2,500 4) in taxes. Irene paid more than 100% of the taxes due for the current year, which was expected to be $9,800. Irene's compliance with the safe harbor rules is due to the fact that the safe harbor covers only 90% of the current-year tax. Therefore, she is not subject to any penalties.
Example Seven:
Waldo submitted an extension request for his 1040 taxes on April 15 of this year. Waldo owed $3,100 in federal taxes when he requested the extension. Waldo failed to pay any of his tax liability with his extension. By July 15th of the current year, Waldo had paid off the taxes owed.
An underpayment penalty will be imposed on the taxpayer. It is necessary to file a Form 1040 for a calendar-year taxpayer by April 15. By filing Form 4868, a taxpayer can request an automatic extension of the due date (to October 15). Regardless of any extension of the filing deadline, any tax liability still needs to be paid by the original due date. An underpayment penalty will be issued to Waldo because he failed to pay his tax liability when filing the extension.
Example Eight:
Alex and Marie are a married couple who are both studying full-time in college. The current year's combined income for them is $27,000. If you are married and filing jointly, the standard deduction is $29,200. The amount of taxes withheld is $1,750. March 1 was the day they filed their Form 1040.
The threshold amount is not exceeded by any taxes owed. Alex and Marie's tax refund is due to the fact that the standard deduction for married filing jointly of $29,200 is greater than their combined earnings of $27,000. No penalties will be incurred because taxes are not owed.
