In fact, tax prepayments ensure that the government receives tax revenue throughout the year rather than in a single lump sum at the end of the year.
Here's a quick recap of your points:
- If you paid too much tax in a previous year, it can be applied to your current year's tax liability.
- Income tax, Social Security, and Medicare taxes are covered by employers by withholding a portion of an employee's wages.
- Estimated tax payments can be made directly to the IRS by taxpayers or others.
- If a taxpayer has multiple jobs and their total FICA tax withheld exceeds the annual limit, they are considered to have made a prepayment.
- Tax credits that can be refunded are available to the taxpayer even if they exceed the total tax liability.
It's true that FICA tax payment, which is used to fund Social Security and Medicare, is not a prepayment of income tax but a distinct obligation.
To demonstrate how to calculate estimated taxes, here's an example.
Ms. W, who is unmarried, has come to the conclusion that her total tax bill for Year 2 will be $10,000. W is obligated to pay the estimated tax if:
In general, individuals are required to make estimated tax payments or face a penalty. Estimated tax payments are the treatment for amounts withheld from wages. The annual estimated payment that must be made is equal to the lesser of (1) 90% of the tax for the current year, or (2) 100% of the tax for the prior year. Assuming Ms. W’s tax liability for Year 2 is $10,000 and her Year 1 tax liability was $9,000, the $8,500 withheld from her Year 2 wages does not meet the required annual estimated payment.
This is yet another example of the safe harbor rule:
The amount of his estimated tax payments for 2025 is being determined by Andrew. His 2024 salary was reduced by $25,000 due to his employer withholding it, and his adjusted gross income (AGI) is $59,000. In 2025, Andrew anticipates the same withholding. Given that his 2024 total tax is $29,000, using the safe harbor rule for payments to avoid an underpayment penalty, how much 2025 tax must Andrew pay by each quarterly estimated payment deadline?
To calculate the quarterly estimated tax payment using the safe harbor method, Andrew must subtract the amount withheld by his employer of $25,000 from the total prior-year tax of $29,000 to get the estimated annual payment of $4,000. The IRS requires 25% of this amount be paid quarterly. Thus, Andrew’s estimated quarterly payment in 2025 is $1,000 ($4,000 ÷ 4).
