Global Tax Insights
Should You Increase Your Withholding Before Year End?December 07, 2015
Determining whether you’ve paid enough tax during 2015 to avoid penalties.
Maybe. If you have business or self-employment income (or you have large amounts of investment income) and haven’t made sufficient quarterly estimated payments during the year, increasing your withholding may allow you to avoid underpayment penalties. These penalties apply when sufficient tax hasn’t been paid over the course of the year via withholding and/or estimated tax payments.
Withholding / Estimated Taxes 101
Generally, withholding and estimated tax payments must, at minimum, add up to either 90% of your 2015 tax liability or 100% of your 2014 tax liability. If your 2014 adjusted gross income was more than $150,000 ($75,000 if married filing separately), for the latter test your total 2015 payments must equal at least 110% of your 2014 liability.
If most of your income comes from salary and other sources from which taxes are withheld before you receive payment (such as retirement plan distributions), standard withholding likely is enough for you to avoid penalties for not having paid sufficient tax throughout the year. But if more than a small portion of your income comes from self-employment, business activities, investing or other sources from which taxes aren’t withheld, you likely need to make quarterly estimated tax payments to avoid these penalties.
Why Withholding Beats a Large Q4 Estimated Tax Payment
Unfortunately, if you discover that you didn’t make large enough payments in earlier quarters, you can’t avoid penalties simply by making a larger payment in the fourth quarter. But you can avoid penalties by increasing your withholding to cover the tax shortfall. Why?
Withholding is considered to have been paid ratably throughout the year. And this withholding doesn’t have to be from your salary; it can be from bonuses or, if you receive Social Security or retirement plan distributions, it can be from that.
Don’t Forget About the 0.9% Additional Medicare Tax
Another withholding obligation to consider if your FICA wages and net self-employment income for 2015 will exceed $200,000 ($250,000 if married filing jointly or $125,000 if married filing separately) is the additional 0.9% Medicare tax. Your employer is obligated to withhold the tax beginning in the pay period during the year when the wages it pays you exceed the $200,000 threshold (regardless of your filing status).
But let’s say your salary is $175,000 and you also have $100,000 in self-employment income from consulting. Your employer won’t withhold the additional Medicare tax because your compensation is under the threshold. So you’ll need to either make estimated tax payments for your additional Medicare tax liability or request that your employer increase your income tax withholding. That extra income tax can be applied to your Medicare tax obligation and allow you to avoid penalties.
If you need help determining whether you’ve paid enough tax during 2015 to avoid penalties, please contact us. With year end rapidly approaching, there isn’t much time left to increase your 2015 withholding. So you’ll need to act soon. Questions? Contact us.