If you don’t pay enough tax during the year—including payroll withholding and quarterly installments—you could be assessed an “estimated tax” interest rate penalty for the underpayment.
Strategy: Make sure you qualify for one of the tax law “safe harbors.” You have three options:
- Pay at least 90% of the current year’s tax liability.
- Pay at least 100% of your 2007 tax liability (110% if your AGI for 2007 exceeded $150,000).
- Pay installments under a special annualized basis. This option is available only if you receive more income on a seasonal basis.
Usually, the easiest way to avoid a penalty is to base payments on 100% (or 110%) of the prior year’s tax liability. Reason: You know exactly how much you have to pay this year.
Tip: If you adjust your W-4 after you clear the Social Security wage base ($102,000 for 2008), you can use the employment tax savings for additional income tax withholding.