Many people (i.e. employees) are enrolled in pay-as-you-earn tax schemes where their employer withholds the money that they owe in federal income taxes, making their financial life a lot easier. However, many people are not eligible for these monitored systems, and thus have to monitor their tax much more carefully. People who receive income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes, and awards should all be making estimated tax payments. Sometimes the amount of tax money withheld from your employer (or another source of income) is not enough, and in this case, you should be making estimated tax payments also.
People who are required to pay estimated taxes should be making 4 payments to the IRS throughout the year. The deadlines for these payments are April 15, June 15, September 15, and January 15. If you miss these payment due dates or do not pay enough on one of these dates, you will be charged a penalty by the IRS.
Who must pay estimated taxes?
Individuals, including sole proprietors, partners, and S corporation shareholders, should generally pay estimated taxes if they expect to owe $1,000 or more in taxes upon the filing of their tax return. This also generally applies to corporations if they expect to owe $500 or more in taxes upon the filing of their tax return.
How do you calculate these estimated taxes?
This can be a complicated process, and often requires you to do some guesswork based on your historical tax data and future predictions. First of all, you should estimate your expected adjusted gross income, taxable income, deductions, and credits for the year. If you expect to earn more (or less) than you did last year, you should take this into account when calculating.
After you have ascertained a sensible estimation of these figures, you then need to add a small number of simple calculations in order to figure out how much you’ll owe in your estimated quarterly tax payments. The forms that the IRS provides (Form 1040-ES for individuals or Form 1120-W for corporations) will help you and guide you through these calculations in further detail, as there are many variables depending on your circumstances.
The IRS understands that these estimations can be difficult to make, and provides certain safety nets and guidelines for you to avoid being charged penalties. Paying at least 90% of the taxes that you owe this year will avoid any penalties. Also, paying 100% (the same amount) of the tax you paid last year is referred to as a “safe harbor” and will see you avoid any penalties. You will, however, have to make up any differences in tax when you reach the end of the tax year. It should be noted that this “safe harbor” percentage jumps to 110% of the previous year’s taxes for people whose income is $150,000 or more.
How to pay estimated taxes
Individuals should fill out IRS form 1040-ES and corporations should fill out IRS form 1120-W. Upon completion, the form(s) will instruct you on where the form and check need to be sent, as this will vary depending on where you live.