Do You Need to Make Estimated Tax Payments?

The US tax system requires taxpayers to pay tax on income as it is received during the year, a pay-as-you-go system. The IRS says, “Pay as you go, so you won’t owe.” While you can wait until the end of the year to pay your taxes, you can’t do so without incurring some significant  IRS penalties and interest. To help our clients avoid underpayment penalties and interest, we often set up a schedule of estimated tax payments, calculating how much tax should be paid and the dates by which the payments should be made.  This article will discuss who needs to make estimated tax payments, when these payments are due, and IRS penalties for taxpayers who don’t make proper estimated tax payments.

In general, there are two ways to pay tax:

• Withholding from your pay, your pensions, or certain government payments, such as Social Security.
• Making quarterly tax payments during the year.

Many people receive unearned income like dividends, interest, and capital gains. Additionally, many individuals earn self-employment income. In any case where withholding does not occur, a taxpayer should theoretically pay some income tax every time they receive income. Since this is burdensome, the IRS allows taxpayers to pay taxes in quarterly installments. These installments are also used to pay other taxes such as self-employment tax (social security and Medicare taxes) and alternative minimum tax.

Who must pay estimated tax

Individuals, including sole proprietors, partners, and S corporation shareholders, generally must make estimated tax payments if they expect to owe tax of $1,000 or more when their tax return is filed. Corporations make estimated tax payments if they expect to owe tax of $500 or more when their return is filed.

How to calculate estimated taxes

To calculate quarterly payment amounts for estimated taxes:

• Calculate expected gross income from all sources for the year. Many start with prior year amounts and then adjust for any changes anticipated in the current year.
• Subtract estimated deductions from gross income.
• Multiply the income minus deductions by current year tax rates.
• Calculate and add any self-employment tax you may owe.
• Subtract anticipated tax credits and any W-2 withholding.
• Divide the final estimated tax liability by four.

There is also a safe harbor estimate that is easier to calculate, but not quite as accurate. The safe harbor amounts are also paid in quarterly installments.

• Pay 90 percent of the tax shown on your tax return for the current year.
• Pay 100 percent of the tax liability on your previous year tax return (you can choose this option if your adjusted gross income is under certain limits).
• Pay 110 percent of the previous year’s tax liability if a high earner.

How to pay estimated taxes

The IRS makes giving them money almost effortless. Getting money back from them is another story. But we digress. You can make estimated tax payments by mail with Form 1040-ES, by phone, using a mobile app, or through your online account. If you use an online account, you can also see your payment history and other tax records. Some taxpayers allow the IRS to automatically deduct estimated tax payments from their accounts on the dates they are due.

Most taxpayers make their estimated tax payments quarterly, but they can be paid more frequently. If you wish, you can pay estimated taxes weekly, bi-weekly, or monthly. You can also choose to pay the entire year’s estimated amount in the first quarter. Whatever payment interval you choose, you must have paid the correct amount by the end of each quarter.

Estimated tax payment deadlines:
April 15 for first quarter estimates (January 1 – March 31)
June 15 for second quarter estimates (April 1 – May 31)
September 15 for third quarter estimates (June 1 – August 31)
January 15 of following year for fourth quarter estimates (September 1 – December 31)

Penalties for underpayment of estimated tax

Failure to pay proper estimated tax penalties are calculated for each quarter in which you do not pay the correct amount of tax. The penalty is based on the amount and duration of the underpayment. The IRS also charges interest on the underpayments. Because the estimated tax penalties are calculated quarterly, you may have to pay a penalty even if you are due a refund when you file your tax return.

We strongly recommend making estimated tax payments on time and in the proper amounts. We don’t like seeing our clients pay IRS penalties and interest that could be easily avoided. As with any tax-related topic, there are many nuances associated with estimated tax that may or may not apply to you. If you have any questions or concerns related to calculating an estimated tax or how to make payments, give one of our tax professionals a call. We love hearing from you!