Do you owe estimated taxes?
The US tax system is a pay as you go system, which means you are supposed to pay taxes as you earn income. This isn’t a problem for many people because their employers withhold their taxes from their paycheck. But if you do not have enough money withheld from your paycheck or if you have additional income from self-employment, investments, real estate, or other means, you may need to pay self employment tax or make estimated tax payments.
Who Needs to Pay Estimated Taxes?
The money employers automatically withhold from your paycheck is sent in to the IRS and your state if you live in a state that assesses income tax. Ideally, the exact amount of money would be withheld and you won’t end up owing any money or receiving a tax return. However, it’s not always easy to predict your year end income or which deductions you will have throughout the year, particularly if you have unsteady income. Because of this, many entrepreneurs have to deal with self-employment and estimated taxes.
You must pay estimated tax if both of the following apply:
- You expect to owe at least $1,000 in taxes after subtracting your withholding and credits.
- You expect your withholding and credits to be less than the smaller of;
- 90% of your current year tax liability, or
- 100% of the tax shown on your previous year’s tax return.
In other words, the amount of estimated taxes you need to pay to avoid penalties is the smaller of 90% of what you will owe this year, or at least 100% of what you owed last year (110% for high income earners).
Who Does Not Have To Pay Estimated Tax
You should not have to pay estimated taxes if you will owe less than $1,000 in taxes this year, or if your employer withholds enough money through your paychecks. You can adjust your W-4 to withhold more or less money depending on your personal situation. Use the IRS Withholding Calculator to determine how many dependents you should claim, which will affect the amount of taxes withheld from your paycheck.
How To Determine How Much Estimated Tax to Pay
If you have steady income that is not subjected to automatic tax withholdings, or if you have a fairly good idea how much money you will earn in a given year, you can determine how much estimated taxes to pay with estimated tax worksheets or software. IRS Form 1040-ES includes a worksheet to calculate how much you should pay for your estimated taxes. You can also find calculators in most commercial tax software programs like TurboTax and H&R Block Online (H&R Block Review).
Irregular income? It can be difficult for individuals with irregular income to predict how much they will earn in a given year. Thankfully there is a safe harbor rule, which states that as long as you pay 100% of your previous year’s total tax liability in withholding and/or estimated taxes, you’ll be exempt from underpayment penalty regardless of your final tax amount (remember the 90% of current year or 100% of last year rule from above?).
A simple way to qualify for the safe harbor rule. To qualify for the Safe Harbor Tax Rule and avoid penalties, take your previous year’s tax obligation, divide by four, and make four equal payments by the estimated tax deadlines. Add 10% to last year’s tax total if you are a high income filer.
How much per installment? The IRS wants estimated taxes to be paid in equal installments, regardless of when you earn your income. This can be tricky when you don’t know how much you will earn, or if you typically have lean months in the beginning of the year, and earn more money in the latter part of the year. The easy way to avoid this is to follow the safe harbor method mentioned above. But if you want to do it a different way, then I recommend this article about calculating your estimated tax payments.
How I Determine My Estimated Tax Obligations
My accountant bases my estimated taxes based on my previous year’s income, which is how many people calculate their estimate taxes. However, you may wish to reassess your calculation as your year progresses. You may find that your income situation is very different from the previous year and you may end up owing more or less than your estimated tax payments justify. If you owe more, then you can wait and pay them when you file your taxes, as long as you meet the safe harbor minimum as described above. But if you pay too much, you may end up receiving a large tax refund. I recommend consulting with a tax professional if you plan on changing your estimated tax payments during the year.
Estimated Tax Deadlines
Estimated taxes are due four times per year on the dates listed below, or the following business day if the due date falls on a weekend or holiday. (Note the due dates are not spaced exactly 3 months apart):
- April 15th
- June 15th
- September 15th
- January 15th
Note: You must still pay your estimated taxes by the deadline, even if you have filed an extension on your taxes.
How to File and Pay Your Estimated Taxes
There are two ways you can file and pay your estimated taxes: by paper or electronically.
- Pay by mail. Use IRS Form 1040-ES (download pdf here) to calculate your estimated taxes. Then fill out a voucher on the form to send along with your estimated tax payment.
- Pay Electronically. If you prefer to pay your taxes electronically, you can sign up for the Electronic Federal Tax Payment System (EFTPS) to pay your estimated taxes online. It can take up to 2 weeks to receive your PIN in the mail, so plan accordingly.
I usually pay my estimated taxes by mail each quarter. My accountant gives me the estimated tax vouchers for the next year. I place them in a large manilla envelope and set calendar reminders to make the payment and send in the check. You can do the same thing electronically. Either way, the key is to be organized and not miss your scheduled estimated tax payment. Failing to make your payment can lead to penalties and/or fees.
Here are more tips for organizing your tax documents.
Consult a professional for more details
The information in this article should give you a decent overview of how estimated taxes work and how they might apply to your situation. But keep in mind that each situation is unique and this may not cover all people and situations. Your specific tax situation may be different; please consult an accountant or IRS documentation for information specific to your needs.
Another note – be sure your tax preparer is properly licensed in your state. In California, they are required to get a “tax preparer bond” to protect you from a preparer’s misstatements, misrepresentations, dishonesty, fraud, deceit or any other unlawful acts or omissions. This is just one layer of protection that comes along with licensing.
Additional IRS Resources:
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Bryce @ Save and Conquer says
My wife and I get enough dividends in our taxable investments at the end of the year that it is wise for us to make an estimated tax payment before Jan 15. We’ve done that for the past decade, and things work out well on April 15 with us owing the IRS a few hundred dollars, and the state usually owing us a hundred or so.
Ryan Guina says
That’s a great point, Bryce. Many people only think of estimated taxes for self-employment income. But it’s important to remember that estimated taxes may be due for investment income and other forms of income.
I started a new job this year. My boss, who owns the company hadn’t decided whether I would be treated as a contract worker or employee until a few weeks ago. He decided to treat me as an employee, however, for the first seven months or so no taxes have been taken out of my check nor have I made estimated tax payments. Will I be penalized for not making estimated payments? What should I do? Thanks!
Jared, this is a situation I am not familiar with. You probably need clarification from your employer regarding when your offical start date was as an employee because your employer is required to pay unemployment insurance and other taxes for all employees, as well as the employer portion of employment taxes. Then you will need to pay your taxes based on your employment status. I recommend sitting down with your employer to get this situation resolved as quicky as possible (it may also be a good idea to contact an accountant to help you better understand your options). And on your end, it will be a good idea to start saving some money in case you end up with a big tax bill.
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