Quarterly Tax Payments
As Ben Franklin once said, “In this world nothing can be said to be certain, except death and taxes”. The IRS expects you to pay taxes on the income that you receive during the year, whether from a corporate job, self-employment, or other sources. The IRS requests that you make tax payments to them as your income is earned, not just when you file your tax return.
While those who are employed will always have taxes withheld from their paychecks and sent directly to the IRS, some people will need to make these tax payments on their own in the form of Estimated Tax Payments. The amount of these payments will be based on income from self-employment, business earnings, interest, rent, dividends and any other income sources.
The IRS requires estimated tax be paid quarterly, in 4 equal installments. If you underpay your estimated tax, you will have to write a bigger check to the IRS when you file your tax return, as well as pay penalty for underpayment. If you overpay your estimated tax, you will receive the excess amount as a tax refund (similar to how withholding tax on a paycheck works).
There are several reasons you might need to pay quarterly tax payments. In general, if your tax owed when you filed your return was more than $1,000, you will either need to increase your withholding of tax through your paycheck, IRA distribution, or Social Security check, or you can begin making quarterly payments. Self-employed taxpayers are expected to make quarterly payments, as there is no withholding tax on compensation to self-employed taxpayers.
How should I figure what I owe?
You can come up with a good estimate of your income and deductions that you will report on your federal tax return. For self-employed individuals, you will want to consider your gross business income, less business deductions. For those who have income in which tax is not withheld (Social Security, IRA distributions, investment income, capital gain), you will want to consider how this additional income affects your total tax liability, less any withholding of tax you may have on your W-2.
The IRS has a form – IRS Form 1040-ES (Estimated Tax For Individuals) – which you can use to calculate your estimated tax payments. Calculating this number is similar to figuring out your annual tax liability for that year. You will need to know your income, deductions, credits, and paid taxes.
When do I pay?
For the purpose of estimated tax, the year is divided into 4 payment periods. Each period has a specific payment deadline, and failing to pay on time can result in IRS penalties:
January 1 — March 31: Deadline is April 15
April 1 — May 31: Deadline is June 16
June 1 — August 31: Deadline is September 15
September 1 — December 31: Deadline is January 15 (of the following year)
Avoiding estimated taxes altogether
Are you already panicking at the prospect of struggling through worksheets and more tax forms? You might have another option.
If you have wage income in addition to untaxed earnings, file a new W-4 at work and ask your employer or HR department to start withholding more income tax, to cover your shortfall. This strategy also works for couples who file jointly, but with only one spouse having wage income subject to withholding.
Remember that it is important to submit your tax payments on time. Even if you’ve already missed a few installments for estimated tax, you should still try to pay them as soon as possible. Your penalty for underpayment will be reduced based on the timeliness of your payments relative to the due dates for quarterly payments.
Finally, one other way to avoid IRS penalties is to make estimated payments based on the prior year total tax owed (referred to as the safe harbor method):
- If your prior year Adjusted Gross Income (line 37 on your 2016 Form 1040) was $150,000 or less, you can avoid a penalty if you pay either 90% of this year’s income tax liability or 100% of your income tax liability from last year (dividing what you paid last year into four quarterly payments). This rule helps if you have a big spike in income one year, say, because you earn more self-employment income than you anticipated, or sell an investment for a huge gain. If wage withholding for the year equals the amount of your tax liability in the prior year, then you do not need to pay estimated taxes, no matter how much extra tax you will owe on your windfall.
- If your prior year’s Adjusted Gross Income was greater than $150,000, then you must pay either 90 percent of this year’s income tax liability or 110 percent of last year’s income tax liability if you want to avoid the underpayment penalty