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It’s not enough if you pay your income tax to Uncle Sam, it’s also a question of when the tax is paid. You could be assessed an “estimated tax” interest charge penalty if you don’t fork over the required tax in a timely fashion. The penalty is equal to the going interest charge rate for other tax underpayments.

Fortunately, you can avoid any penalties if you qualify under one of three safe-harbor methods. The new economic stimulus law eases one of these safe harbors for qualified small business owners.

Strategy: Use the safe-harbor method that suits you best. You might even switch midway through the year. There’s nothing in the tax law requiring you to stick with the same method through thick and thin.

Some taxpayers simply like the idea of overpaying the IRS during the year and getting back a big fat tax refund the following year. But that effectively gives the government an interest-free loan. In this uncertain economy, every dollar you can hold onto is valuable.

Here’s the whole story:
Generally, you’re required to pay annual income tax in quarterly estimated tax installments or through payroll tax withholding (or a combination). The quarterly due dates for estimated tax payments are April 15, June 15, Sept. 15 and Jan. 15 of the following year (or the following business day if the due date falls on a weekend or holiday). Failure to pay the required tax can result in the interest charge penalty.

However, you can sidestep any problems by using one of these safe harbors:

1. You pay at least 90%
of the current year’s tax liability. This requires you to make a calculated “guesstimate” of your current tax situation.

2. You pay at least 100% of the prior year’s tax liability
(110% if your AGI for the prior year exceeded $150,000). This is often the easiest method to use because you know the exact amount of your previous tax liability.

3. You pay at least 90% of the current year’s “annualized income.”
The annualized method often works well for certain individuals, such as independent contractors, who receive most of their income on a seasonal basis.

New law change:
Under the new law, you can base the second safe-harbor method for 2009 installments on 90% of the prior year’s tax liability—instead of the usual 100% figure—if your AGI for last year was less than $500,000 and more than half of the income reported on last year’s return was income from small business activities. For this purpose, a “small business” is a trade or business with an average number of 500 employees or fewer.

Of course, the easiest way isn’t always the best way. For instance, you might pay the IRS less upfront—and keep more tax dollars in your own pocket—by switching safe-harbor methods before the end of the year.

No matter which safe-harbor method you use, each quarterly installment can stand on its own. Caveat: The payment you make for any particular quarter, plus the amounts paid in previous quarters, must equal the amount you would have paid if you were using the new method all along.

Tip: The IRS provides work sheets to help you calculate estimated tax liability in Pub. 505, Tax Withholding and Estimated Tax. Find them at www.irs.gov/pub/irs-pdf/p505.pdf.

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