Guide to Estimated Tax Payments
If you collect a regular paycheck from an employer, then you probably know you have to file an income tax return in April each year. When you’re self-employed or receive income other than employment wages or salary, you might also be responsible for making estimated tax payments.
Estimated taxes are an advance payment against your expected tax liability for the year. The IRS requires certain people and businesses to make estimated tax payments four times each year.
Not sure if you need to make estimated tax payments or how much to pay? Here’s a closer look at how they work, including:
• What are estimated tax payments?
• Who needs to make estimated tax payments?
• What are the pros and cons of estimated tax payments?
• How do you know how much you owe in estimated taxes?
What Are Estimated Tax Payments?
Estimated tax payments are payments you make to the IRS on income that is not subject to federal withholding. Ordinarily, your employer withholds taxes from your paychecks. Under this system, you pay taxes as you go, and you might get money back (or owe) when you file your tax return, based on how much you paid throughout the year.
So what is an estimated tax payment designed to do? Estimated tax payments are meant to help you keep pace with what you owe so that you don’t end up with a huge tax bill when you file your return. They’re essentially an estimate of how much you might pay in taxes if you were subject to regular withholding, say, by an employer.
Estimated tax payments can apply to different types of income, including:
• Self-employment income
• Income from freelancing or gig work (aka a side hustle)
• Interest and dividends
• Rental income
• Unemployment compensation
• Capital gains
• Prizes and awards.
If you receive any of those types of income during the year, it’s important to know when you might be on the hook for estimated taxes. That way, you can avoid being caught off-guard during tax season.
How Do Estimated Tax Payments Work?
Estimated tax payments allow the IRS to collect income tax, as well as self-employment taxes from individuals who are required to make these payments. When you pay estimated taxes, you’re making an educated guess about how much money you’ll owe in taxes for the year.
The IRS keeps track of estimated tax payments as you make them. You’ll also report those payments on your income tax return when you file. The amount you paid in is then used to determine whether you need to pay any additional tax owed, based on your filing status and income, and the deductions or credits you might be eligible for.
Failing to pay estimated taxes on time can trigger tax penalties. You might also pay a penalty for underpaying if the IRS determines that you should have paid a different amount.
Who Needs to Pay Estimated Tax Payments?
Now that you know what an estimated tax payment is, take a closer look at who needs to make them. The IRS establishes some rules about who is liable for estimated tax payments. Generally, you’ll need to pay estimated taxes if:
• You expect to owe $1,000 or more in taxes when you file your income tax return, after subtracting any withholding you’ve already paid and any refundable credits you’re eligible for.
• You expect your withholding and refundable credits to be less than the smaller of either 90% of the tax to be shown on your current year tax return or 100% of the tax shown on your prior year return.
• The tax threshold drops to $500 for corporations.
Examples of individuals and business entities that may be subject to estimated tax payments include:
• Sole proprietors
• Business partners
• Property owners who collect rental income
• Ex-spouses who receive alimony payments
• Contest or sweepstakes winners.
Now, who doesn’t have to make estimated tax payments? You may be able to avoid estimated tax payments if your employer is withholding taxes from your pay regularly and you don’t have significant other forms of income (such as a side hustle). The amount the employer withholds is determined by the elections you make on your Form W-4, which you should have filled out when you were hired.
You can also avoid estimated taxes for the current tax year if all three are true:
• You had no tax liability for the previous tax year
• You were a U.S. citizen or resident alien for the entire year
• Your prior tax year spanned a 12-month period.
Pros and Cons of Estimated Taxes
Paying taxes can be challenging, and some people may dread preparing for tax season each year. Like anything else, there are some advantages and disadvantages associated with estimated tax payments.
Here are the pros:
• Making estimated tax payments allows you to spread your tax liability out over the year, versus trying to pay it all at once when you file.
• Overpaying estimated taxes could result in a larger refund when you file your return, which could be put to good use (such as paying down debt).
• Estimated tax payments can help you create a realistic budgetif you’re setting aside money for taxes on a regular basis.
And now, the cons:
• Underpaying estimated taxes could result in penalties when you file.
• Calculating estimated tax payments and scheduling those payments can be time-consuming.
• Miscalculating estimated tax payments could result in owing more money to the IRS.
Recommended: What Happens If I Miss the Tax Filing Deadline?
Figuring Out How Much Estimated Taxes You Owe
There are a few things you’ll need to know to calculate how much to pay for estimated taxes. Specifically, you’ll need to know your:
• Expected adjusted gross income (AGI)
• Taxable income
You can use IRS Form 1040 ES to figure your estimated tax. There are also online tax calculators that can do the math for you.
If you’re calculating estimated tax payments for the first time, it may be helpful to use your prior year’s tax return as a guide. That can give you an idea of what you typically pay in taxes, based on your income, assuming it’s the same year to year.
When calculating estimated tax payments, it’s always better to pay more than less. If you overpay, the IRS can give the difference back to you as a tax refund when you file your return. If you underpay, on the other hand, you might end up having to fork over more money in taxes and penalties.
Paying Your Estimated Taxes
As mentioned, you’ll need to make estimated tax payments four times each year. The due dates are quarterly but they’re not spaced apart in equal increments.
Here’s how the estimated tax payment calendar works for 2023:
|First Payment||April 18, 2023|
|Second Payment||June 15, 2023|
|Third Payment||September 15, 2023|
|Fourth Payment||January 16, 2024|
The fourth payment for the tax year is always due in January of the following year. Note that these days are not fixed and may change year to year. You don’t have to make the January payment if you file your tax return by the end of the month and pay the entire balance due with your return.
You’ll make estimated tax payments directly to the IRS. You can do that online through your IRS account, through the IRS2Go app, or using IRS Direct Pay. You can use a credit card, debit card, or bank account to pay. Note that you might be charged a processing fee to make payments with a credit or debit card. Certain IRS retail locations can also accept cash payments in person.
Keep in mind that if you live in a state that collects income tax, you’ll also need to make estimated tax payments to your state tax agency. State (and any local) quarterly estimated taxes follow the same calendar as federal tax payments. You can check with your state tax agency to determine if estimated tax is required and how to make those payments.
If you freelance, run a business, or earn interest, dividends, or rental income from investments, you might have to make estimated tax payments. Doing so will help you avoid owing a large payment at tax time and possibly incurring penalties. The good news is that once you get into the habit of calculating those payments, tax planning becomes less stressful.
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What happens if I don’t pay estimated taxes?
Failing to pay estimated taxes when you owe them can result in tax penalties. Interest can also accrue on the amount that was due. You can’t make up those penalties or interest by overpaying at the next quarterly due date or making one large payment to the IRS at the end of the year. You can appeal the penalty, but you’ll still be responsible for paying any estimated tax due.
What if you haven’t paid enough in estimated tax payments?
Underpaying estimated taxes can result in a tax penalty. The IRS calculates the penalty based on the amount of the underpayment, the period when the underpayment was due and not paid, and the applicable interest rate. You’d have to pay the penalty, along with any additional tax owed, when you file your annual income tax return.
How often do you pay estimated taxes?
The IRS collects estimated taxes quarterly, with the first payment for the current tax year due in April. The remaining payments are due in June, September, and the following January. You could, however, choose to make payments in smaller increments throughout the year as long as you do so by the quarterly deadline.
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