If you work on salary for an employer and receive a paycheck on a regular basis, you might not think too much about paying income taxes. This is because you complete a Form W-4 for your employer and they will withhold the amount of taxes you tell them based on your personal filing status and how many dependents you have which will help determine the amount of withholding. After that, your employer will withhold and submit those tax payments to the IRS on your behalf.
But if you are self-employed or own a business, taxes on your income are probably aren’t being automatically withheld and submitted to the IRS. In this situation, you may have to make quarterly estimated tax payments to ensure that your federal and (if applicable) state taxes are paid on time.
Estimated tax payments are due on a quarterly basis in April, June, September, and January of the subsequent year. This year’s April and September estimated tax payments are due on the 17th of the month, while the June (of 2018) and January (of 2019) payments are on the 15th of the month. Failure to pay the right amount of estimated tax on time could result in tax penalties and interest.
Types of Income That May Be Taxable
There is a wide range of different types of income from which taxes usually aren’t withheld and on which estimated taxes must be paid. Some of these might include:
- Income from self-employed and business activities
- Capital gains, interest and dividends earned from investments
- Income from pass-through entities or trusts
- Income from rental and/or royalty activities
- Retirement income (pensions, IRA distributions, Social Security)
- Alimony or “prizes” (whether cash or merchandise)
- Other miscellaneous income
If you must make estimated tax payments, the IRS Form 1040-ES filing instructions can help you determine how much estimated tax you owe. This form also includes a voucher you can use to mail your tax payment to the IRS if you choose to make your payment by check. Or you can make your payment electronically using the IRS’ Electronic Federal Tax Payment System (EFTPS).
Determining Your Tax Liability
The IRS offers a couple of different methods for determining how much your estimated tax payments should be. The simplest method is to estimate your total tax liability for the year, divide this by four and pay this amount each quarter. If you think your taxable income for the upcoming year will be about the same as it was last year, you can make your estimate based on this. Specifically, the IRS requires that you make estimated payments of at least 90% of your actual tax liability for the current year, or either 100% or 110% (in some situations where your income is above a certain amount) of last year’s tax liability.
But if your income is less predictable, you can use what’s referred to as the “pay-as-you-go” or annualized method that’s based on your current income. This method also usually works well if your income fluctuates throughout the year, such as if you’re self-employed and have wide swings in income from month to month. It allows you to estimate your tax liability on a quarter-by-quarter basis, which can result in each quarter’s tax more closely corresponding to that quarter’s income. This method takes a considerable more detailed view at your total income and deductions for the year based on what earnings you have for each quarter to determine what you need to pay in each quarter. It is also more time consuming and complicated but could save you in the long run.
In order to help you guide you through the process of estimated tax payments, the IRS Publication 505, Tax Withholding and Estimated Tax, includes a worksheet to help you determine each quarter’s estimated tax amount. It also includes a worksheet you can use if you’re a sole proprietor to determine the amount of annualized self-employment taxes that should be included with your estimated tax payments.
Also, if you don’t make four equal estimated tax payments, you may need to file IRS Form 2210 with your annual tax return to explain why. Otherwise, you might be charged penalties and interest for underpayment of income taxes.
Avoiding Penalties and Interest
When making estimated tax payments, your goal should be to make sure you pay enough money each quarter so you don’t owe underpayment penalties related to estimated tax payments. Each individual tax situation is different and can vary from year to year, so educate yourself on how the penalty applies to your situation.
The details surrounding the payment of quarterly estimated taxes can be confusing. Therefore, you should consult with a tax professional about your specific situation.
To learn more about taxes and how they fit into your overall strategy, download our free Personal Capital’s Tax Guide.
This blog is for informational purposes only and is intended to offer guidance; not specific legal or tax advice. Clients are advised to consult their CPA before taking action based on this advice.
Brian Wainscoat, CPA
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