Estimated Taxes: Avoid Penalties

For lawyers and law firm owners, understanding estimated taxes is essential to maintaining financial stability and avoiding costly penalties. With fluctuating income streams from self-employment, dividends, or other sources, knowing how to calculate and manage these quarterly payments is critical.

Here’s a comprehensive guide to help you navigate estimated taxes effectively.

What Are Estimated Taxes?

Estimated taxes are periodic payments made throughout the year to cover federal taxes on income not subject to withholding. The U.S. tax system operates on a "pay-as-you-go" basis, which means you must pay taxes as income is earned or received.

Examples of Income Requiring Estimated Taxes:

• Self-Employment Income: Income from law firms, freelance legal work, or other professional services.
• Dividends and Interest: Investment returns not subject to withholding.
• Rental Income: Earnings from leasing residential or commercial properties.
• Capital Gains: Profits from the sale of stocks, bonds, or real estate.
• Alimony Payments: For agreements finalized before 2019.
• Business Earnings: Partnership or S-corporation distributions.

Legal Scenario: A solo practitioner earning inconsistent income from client retainers and settlements must make estimated tax payments to avoid penalties for underpayment.

Who Must Pay Estimated Taxes?

You are required to pay estimated taxes if:

• You expect to owe at least $1,000 in taxes after withholdings and credits.
• Your withholdings and credits are less than:90% of your current year’s tax liability, or100% of your prior year’s tax liability (110% if your prior year’s adjusted gross income exceeded $150,000).

Important Considerations for Lawyers:

• Sole proprietors, partners, and S-corporation shareholders are particularly impacted since they often receive income without withholding.
• Meeting these criteria helps avoid penalties and ensures compliance with IRS rules.

Who Is Exempt from Estimated Taxes?

You may be exempt if:

• You had no tax liability in the prior year.
• You were a U.S. citizen or resident for the entire year.
• Your prior tax year covered a full 12 months.
• Additional Points: If your income is primarily subject to accurate withholding (e.g., via W-2 employment), you may not need to make estimated payments.

Example: A lawyer working part-time for a firm with proper tax withholding on their wages may adjust their Form W-4 to avoid estimated taxes for supplemental self-employment income.

Key Dates for Estimated Payments

The IRS requires quarterly payments based on the following schedule:

• April 15: Payment for income earned January 1–March 31.
• June 17: Payment for income earned April 1–May 31.
• September 16: Payment for income earned June 1–August 31.
• January 15 (next year): Payment for income earned September 1–December 31.

Reminder: If the payment due date falls on a weekend or holiday, it moves to the next business day. Ensuring timely payments helps avoid unnecessary penalties.

Avoiding Penalties and Why It Matters

To avoid underpayment penalties, ensure you:

• Pay at least 90% of your current year’s tax liability, or
• Pay 100% of your prior year’s tax liability (110% for high-income earners).

Special Circumstances: Penalty waivers may apply if you experienced unforeseen events, such as:

• Natural disasters.
• Medical emergencies.
• Significant income changes.

Get Ahead of Tax Deadlines

Navigating estimated taxes can be complex, but timely action can save you money and stress. Whether you’re just starting to handle estimated taxes or need a better strategy, we’re here to help. It’s not too late to catch up on this year’s payments or prepare for the next tax season.

Book your free consultation with Prestige Accounting and Consulting today to create a personalized tax plan that works for you.