Revenue Administrative Bulletin 2021-17

ESTIMATED PAYMENTS FOR INDIVIDUALS AND FIDUCIARIES UNDER THE MICHIGAN INCOME TAX ACT

Approved: November 22, 2021

(Replaces Revenue Administrative Bulletin 1988-49)

RAB 2021-17.  This Bulletin describes the requirements of an individual, estate or trust to pay estimated income tax, the determination of the amount of an estimated tax installment, the computation of any penalties and interest that apply, and the special provisions applicable to certain taxpayers.

Like the U.S. federal income tax system, Michigan income tax for individuals and fiduciaries[1] (Part 1 taxpayers) is generally a pay-as-you-go system.  Income tax liability accrues on income as it is earned, rather than accruing at the end of the tax year and being due for payment on April 15 of the next year.  Part 1 of the Michigan Income Tax Act (MITA) requires that both calendar year and fiscal year taxpayers (other than farmers, fishermen, and seafarers) whose annual tax liability is reasonably expected to exceed $500 after considering credits allowed and amounts withheld must pay quarterly installments of estimated tax.[2]  Taxpayers have the option to pay the total annual estimated tax by the first quarter due date rather than making four quarterly payments.[3]  However, most Part 1 taxpayers pay estimated taxes quarterly. 

Determining the Amount of an Estimated Tax Installment Payment

Most Part 1 taxpayers required to pay estimated taxes pay in installments equal to one-fourth of the taxpayer's annual estimated tax after first deducting the amount estimated to be withheld.[4]  The amount of an estimated tax installment and the period for calculating underpayment of estimated tax for Part 1 taxpayers under the MITA are determined in the same manner as provided in the Internal Revenue Code (IRC).[5] 

Under the IRC, the required annual payment is the lesser of:

1. 90% of the tax shown on the current-year return.[6]  (The percentage is 66²/₃% for farmers and fishermen.  Farmers and fishermen are individuals with at least two-thirds of their current-year or preceding-year gross income from farming or fishing activities.  Michigan treats seafarers the same as farmers and fisherman.); or
2. 100% of the tax shown on the preceding-year return, if the taxpayer filed a return and the return was for a 12-month tax year.[7]  (The percentage is 110% if the taxpayer's adjusted gross income in the preceding year exceeded $150,000, $75,000 if married filing separately.  The 110% rule does not apply to farmers and fishermen or to seafarers for Michigan purposes).[8]

These provisions are known as safe harbors - meaning that at the end of the year, a taxpayer will not incur underpayment penalties if the taxpayer has paid the required amount (the lesser of the above amounts) divided into four periods using one of two methods to calculate the taxpayer's installment payment.  The first method is the Regular Method, where each quarterly installment is equal to 25% of the required annual payment.  The resulting payments will timely pay the quarterly estimated taxes of taxpayers with a steady income. 

The second method is the Annualized Method, which bases the installment payment on a projection of annual income based on the income earned up to the end of the period for which the installment is being calculated.  A taxpayer whose income varies during the year may choose to use the Annualized Method to compute estimated tax, which more precisely connects the amount of an estimated payment to the period in which the corresponding income is earned.[9]  This method is most often used when the taxpayer receives income unevenly during the year (e.g., from a seasonal business, capital gains, severance pay, alimony or bonuses). 

The Annualized Method allows a taxpayer to correlate estimated payments to the income as it is earned and can be used to avoid underpayment of estimates.  It does so by using cumulative periods, with each of the four periods beginning on January 1 and ending on various dates during the year until the final period, which ends on December 31.  Each period includes all previous periods, with the final period encompassing the entire year.  The amount due each installment is a percentage of the yearly required tax based on the taxpayer's cumulative income at the end of each installment period as annualized.[10] 

A taxpayer is not required to use the same method to calculate each quarterly payment.  Instead, a taxpayer can use whichever of the two methods produces the smallest required installment for that period.[11]  Thus, a taxpayer can alternate between methods and still avoid underpayment penalties.  However, if the smaller annualized income installment is used in one period and the taxpayer then selects the smaller regular installment in a subsequent period, the installment in the subsequent period must be increased by the amount saved by using the annualized income installment method to figure any earlier installments.[12]  This is called recapture and is required by the IRC when switching from the Annualized Method to the Regular Method.[13]  It is therefore required by Michigan.

To determine the estimated payment due under the Annualized Method, a taxpayer must first compute taxable income on an annualized basis.  Annualization requires a projection of annual income for the period based on income earned to that point.  Of note, the annualization periods mandated by the IRC and followed by Michigan are not equal three-month periods.  Rather, the first period is three months, the second is five months, the third is eight months, and the fourth is twelve months.  Hereafter in this Bulletin, references to a particular installment period will be called Q1, Q2, Q3, or Q4.  The predefined annualization multipliers on line 2 of the MI-2210 Annualized Income Worksheet, 4, 2.4, 1.5 and 1, are the same as those on line 2 of the federal worksheet.[14]  The multipliers correspond to the full year divided by the number of months in each period.  So, in the first period, for example, 12 ÷ 3 = 4.[15]  When four is multiplied by the cumulative income earned to that point, the result is a projection of annualized income based on the income earned up to that point in the year.  For the second period, a cumulative five months, the income multiplier is 12 ÷ 5 or 2.4[16] and so on for the third (cumulative 8-month) and fourth (full-year) periods.

Example 1

Vanessa earned a total of $18,000 from January 1 through March 31 (Q1) of the tax year.  To calculate Michigan annualized income, Vanessa divides this by the number of months in the period to arrive at a projection of monthly income and then multiplies that result by the number of months in the year.  The equation is thus:  $18,000/3 = $6,000 x 12 = $72,000 annualized income.  (Vanessa can also just use the predefined annualization multiplier and multiply $18,000 by 4 to arrive at an annualized income of $72,000.) 

For a taxpayer with fluctuating income, the annualized income will change from period to period. 

Example 2

Vanessa earned a total of $78,000 from January 1 through May 31 (Q2) of tax year 2020. To calculate Michigan annualized income, Vanessa divides this by the number of months in the period to arrive at a projection of monthly income and then multiplies that result by the number of months in the year.  The equation is thus:  $78,000/5 = $15,600 x 12 = $187,200 annualized income.  (Multiplying $78,000 by the predefined annualization multiplier of 2.4 yields the same result.)

Once projected annual income is calculated using the income multiplier for the applicable period, a taxpayer then subtracts the total annual personal exemption amount and applies the Michigan tax rate to the result to arrive at an annual estimated tax liability.   After credits are applied, the taxpayer next applies the applicable percentage for the period to the annual estimated tax liability.  The applicable percentages of 22.5%, 45%, 67.5%, and 90% are derived from the IRC's requirement that the taxpayer make an annual payment of 90% of the tax shown on the current-year return.[17]  Michigan uses these same percentages in its Annualized Income Worksheet on line 9.[18] 

Example 3  

To calculate the Michigan estimated payment for Q1 in tax year 2020 using the annualized income method, Vanessa would subtract the total annual personal exemption as a single person ($4,750) from the projected annual income (Vanessa's annualized income).  Vanessa would multiply that result by the tax rate of 4.25% and multiply that product by the applicable percentage for Q1.  The equation is thus:  $72,000 - $4,750 = $67,250 x 4.25% = $2,858 x 22.5% = $643.[19]

Example 4

After calculating the estimated payment using the annualized income method, Vanessa can compare that payment to the estimated payment calculated under the regular quarterly method, which is:  $(18,000 - (4,750/4))[20]   x 4.25% = $715.  Since the estimated payment is lower under the annualized income method, Vanessa may choose to pay that amount.  Vanessa's required estimated payment is thus reduced by $72 ($715 - $643). 

For periods after the first period of the tax year, the annualized income installment for the period is the excess, if any, of the calculated amount of tax owed for the period on the annualized income over the aggregate amount of any prior required installments for the taxable year.[21]  Therefore, the final step for determining the required installment payment for periods after the first period is to subtract all prior payments from the amount resulting from applying the applicable percentage to the annual estimated tax.   The resulting amount is the installment payment required under the annualized income method. 

Example 5

For Q2, Vanessa's annualized income is $187,200. (See Example 2.)  To calculate the estimated payment for Q2 in tax year 2020 using the annualized income method, Vanessa would subtract the total annual personal exemption as a single person ($4,750) from projected annual income (i.e. her annualized income).  Vanessa would multiply that result by the tax rate of 4.25% and then multiply that product by the applicable percentage for Q2.  Vanessa would then subtract the prior payment of $643 (calculated in Example 3).  Thus, the equation for calculating Vanessa's Q2 installment is as follows: $187,200 - $4,750 = $182,450 x 4.25% = $7,754 x 45% = $3,489 - $643 = $2,846. 

Estimated Payment Due Dates

For most calendar-year taxpayers, quarterly tax payments are due April 15, June 15 and September 15 of the tax year, and January 15 of the next year.[22]  A payment made with an extension request for more time to file the annual return will be treated as a payment of the annual tax.  An amount credited forward from the prior year will be considered a payment of estimated tax for the first installment period that an estimated tax payment is due.  The due dates are the same for trusts and estates.[23]  There are different due dates for those earning at least two-thirds of their income from farming, fishing or seafaring, as noted in the section below pertaining to such taxpayers. 

Withholding and Overpayments

Income tax withheld under Section 703[24] of the MITA is treated as a payment of estimated tax.[25] This includes tax withheld from a taxpayer's wages, unemployment benefits, sick pay, pensions, annuities, other deferred income, and gambling winnings.   One-fourth of the total withheld for the year is treated as paid on the due date of each installment of estimated tax unless the taxpayer establishes the dates on which withholding actually occurred.[26]  The amount payable as estimated tax, therefore, is only the excess of the estimated tax over the amounts withheld.

Interest

If an underpayment occurs in any quarter, interest accrues from the due date of the payment for that quarter until the underpayment has been paid or to the original due date of the annual return, whichever is earlier. Payments are applied to the earliest unpaid required installment for purposes of calculating interest.  The amount of interest is calculated by multiplying the underpayment amount, the number of days the underpayment goes unpaid, and the daily interest rate.[27]

Penalties

Part 1 taxpayers may be subject to penalties for failure to make a required estimated payment or failure to pay sufficient taxes throughout the year whether through withholding or by making estimated tax payments.  Avoiding estimated tax penalties involves not just making at least the required minimum payment amount for the applicable period but also making timely payments.  Part 1 taxpayers who have a tax liability (after adjusting for withholding) generally must make quarterly estimated tax payments to avoid an underpayment penalty.

There are a few exceptions.  No penalty is imposed on a taxpayer who fails to make an estimated payment if the taxpayer was not required to make estimated payments in the immediately preceding tax year.[28]  Also, no penalty is imposed for any underpayment of a Q4 estimated payment if the taxpayer files a return for the taxable year on or before January 31 of the following taxable year and pays in full the amount computed on the return.[29] 

Penalty is 25 percent of the tax due (with a minimum of $25 per quarter) for failing to make estimated payments[30] or 10 percent (with a minimum of $10 per quarter) for failing to make sufficient estimated payments or making estimated payments late.[31]  Taxpayers may be subject to penalty and interest even if they are due a refund when they file their income tax return.

If a payment is made after the due date for the installment, then the payment is applied to the period in which it is received for purposes of calculating penalties.  The underpayment penalty applies on a quarter-by-quarter basis. If an overpayment occurs in any quarter, the overpayment amount is carried forward to the next quarter and applied as a timely payment to that respective quarter.  For purposes of penalty calculation, payments are not carried back to offset underpayments in previous quarters. 

Example 6

In tax year 2019, Vanessa earned $124,400.  Vanessa's Michigan personal exemption in tax year 2019 was $4,400 resulting in a taxable income with no credits of $120,000.  Based on this taxable income, Vanessa paid Michigan income tax of $5,100 ($120,000 x 4.25%).  Four equal installments of Vanessa's prior year's tax would be $1,275 each.  Vanessa expected to earn less in 2020 and chose to make four equal estimated payments of $1,200 each for a total of $4,800 for the year.  In tax year 2020, however, Vanessa earned taxable income of $24,000 in Q1, $26,000 in Q2; $85,000 in Q3, and $11,000 in Q4 for a total of $146,000.  With an annual personal exemption of $4,750 for 2020 with no credits, Vanessa's taxable income was $141,250.  Vanessa's 2020 tax liability is, therefore, $6,003 ($141,250 x 4.25%).

Vanessa's required annual payment is the lesser of 100% of her prior year's (2019) tax ($5,100) or 90% of her current year's (2020) tax (90% x $6,003 = $5,403).  Since Vanessa only paid $4,800 in tax, Vanessa did not pay enough to qualify for either of the statute's penalty safe harbors.  Vanessa must therefore determine which quarters were underpaid and calculate the appropriate interest and penalty.  For each quarter Vanessa may choose either the regular equal installment method or the annualized income method to calculate any underpayment.  A comparison of Vanessa's options is represented in Table 1 below.

First, Vanessa compares which figure is lower, 100% of the prior year's tax ($5,100), or 90% of the current year's tax ($5,403).  Since 100% of the prior year's tax is lower, Vanessa uses that number divided into four equal installments and compares the result to the payment due under the annualized income method.  Table 1 shows Vanessa's cumulative tax paid under each method as compared to the actual tax paid and demonstrates that Vanessa should choose the annualized method for quarters one and two and the equal installment payment method in quarters three and four to calculate the underpayment. 

Table 1

Because Vanessa overpaid in Q1 and Q2, Vanessa pays no penalty.  The Q1 overpayment was applied to Q2 and when combined with Vanessa's estimated payment of $1,200 resulted in an overpayment of $196 for Q2.  The overpayment is carried forward and applied to Q3 along with Vanessa's estimated payment of $1,200, resulting in a total estimated payment of $1,396.  Since the required minimum payment for Q3 is $1,621, Vanessa is underpaid by $225. Vanessa will incur a penalty of 10% (or $23) for Q3.  Vanessa will also incur interest on the $225 underpayment from the Q3 due date, September 15, 2020, until the next payment is received (January 15, 2021, for purposes of this example).  At the prime rate in effect for the two periods covered by this underpayment, the interest due is $4.[40]

In Q4, Vanessa's $1,200 estimated payment was $75 less than the $1,275 required minimum payment.  If Vanessa pays the $75 in full with a return filed on or before January 31, Vanessa will incur no penalty.  If Vanessa files and pays this amount after January 31, Vanessa will incur a penalty of $10 (the greater of $10 or 10% of $75).  Vanessa must, however, pay interest on the $300 cumulative underpayment in Q4 ($5,100 - $4,800) from the Q4 due date of January 15, 2021, until its paid or until the original due date of the annual return, whichever is earlier. At the prime rate in effect for the period covered by this underpayment, the interest due is $3.[41]

Example 7

Victor, a single filer, earned $150,000 in tax year 2019.  Victor's Michigan personal exemption in tax year 2019 was $4,400, resulting in a taxable income with no credits of $145,600.  Based on this taxable income, Victor paid tax of $6,188 ($145,600 x 4.25%) in 2019.  Victor's income from wages is generally steady but Victor also receives dividends twice a year, in April and December.  In 2020, Victor earned $8,000 per month in wages and received a $30,000 dividend in April and a $50,000 dividend in December, resulting in a total income for 2020 of $176,000.  Victor's taxable income net of the annual exemption of $4,750 for 2020 with no credits was $171,250.  Tax on 90% of Victor's taxable income for 2020 is $6,550.  Victor paid estimated payments of $1,400 per quarter.  A comparison of Victor's cumulative tax ­­­calculated under each method is shown in Table 2.

Table 2

Because Victor overpaid in Q1, this overpayment is carried forward and applied to Q2, but when added to the Q2 estimated payment of $1,400, still leaves Victor underpaid by $294 ($2,221 - [$1,400 + $527]).  Victor will incur a penalty of 10% (or $29) for Q2.[46]  Victor overpaid in Q3; so, no penalty is due, and the overpayment is carried forward for penalty purposes to Q4.  Though Victor's estimated payment of $1,400 for Q4 was actually $879 short of the required minimum payment of $2,279, Victor's prior quarter overpayment of $291 reduces the underpayment to $588.  If Victor pays this amount in full with a return filed on or before January 31, Victor will incur no penalty.  If Victor files and pays this amount after January 31, Victor will incur a 10% or $59 penalty.

Farmers, Fishermen, and Seafarers

MITA follows IRC 6654, which provides relaxed estimated payment requirements for fishermen and farmers; it also treats seafarers the same as fishermen and farmers.[47]  Only one installment of estimated tax is required of these individuals.  It is payable on January 15 following the close of the taxable year and need only be the lesser of two-thirds of the current year's liability or 100 percent of the preceding year's tax.[48] Moreover, even the January 15 payment can be skipped without penalty if the taxpayer's return is filed by March 1 and all tax shown on the return is paid no later than March 1.[49] 

Changing Filing Status

A taxpayer who changes filing status from married filing joint in the prior year to married filing separate in the current tax year must use that taxpayer's share of the tax on the joint return to compute the estimated tax under the safe harbors.[50]   

To compute 100% of the tax shown on the prior year return, determine the tax each spouse would have paid had they filed separate returns for the prior year using the same filing status for the current year.  Then multiply the tax on the joint return by the following fraction:

The tax the separate filer would have paid had that individual filed a separate return _____________________________________________________________________________

The total tax both spouses would have paid had they filed separate returns[51]

A taxpayer who changes filing status from married filing separate in the prior year to married filing joint in the current tax year must base the estimated tax payments for the joint return on the sum of both spouses' individual prior year tax liabilities.  The couple's combined prior year adjusted gross income determines whether the 100 percent or 110 percent threshold applies.[52] 

In the event that one spouse files a separate return in the current year and the other spouse files a valid joint return for the same tax year, the joint return is the original return of both spouses for the purpose of determining the penalty.[53] 

Impact of Amended Returns on Determining Underpayment Penalty

Because the amount of an estimated tax installment is determined in the same manner as provided in the IRC, Michigan follows the IRS treatment of amended returns as they relate to the computation of penalties for underpayment of estimates.  The safe-harbor provisions require estimates to be based on a percentage of the "tax shown on the return," either the current year or prior year return.  The phrase "tax shown on the return" has been judicially interpreted to mean a timely filed return.[54]  The amount of tax due on an amended return may not be used to determine underpayment of estimate penalties unless the amended return is filed before the due date for filing the original return (including extensions).[55]

If a taxpayer files an amended return after filing the original return and before the due date for filing the original return (including extensions), the amount of an underpayment of estimated tax will be based on the amount of tax determined due on the amended return.  If both the original return and the amended return are filed later than the due date of the return (including extensions), the underpayment of estimated tax will be based on the tax determined due on the amended return.