What Are Estimated Taxes?
The US tax system requires you to pay taxes as you make money. You’re required to pay taxes throughout the year as you earn income rather than waiting until April 15th.
When you’re employed, you don’t really have to worry about this because your employers take care of it for you. They withhold taxes from your paychecks.
It’s more complicated when you are self-employed, when you don’t have enough money withheld, or when you earn additional income in real estate, investments, alimony or other means. You may need to pay quarterly estimated taxes yourself not to pay penalty.
Who Needs to Pay Estimated Taxes?
The general guideline is that you should pay estimated tax if your withholding and credits don’t cover 90% of your current year’s tax liability.
More precisely, you must pay estimated tax if both of the following apply:
1. you expect to owe at least $1,000 in tax after subtracting your withholding and credits
2. you expect your withholding and credits to be less than the smaller of;
90% of the tax to be shown on your current year’s tax return, or 100% of the tax shown on your previous year’s tax return.
Who Does Not Need to Pay Estimated Taxes?
1. You do not have to pay estimated taxes to the IRS if your current year’s tax due will be less than $1,000 after subtracting withholding and credits.
2. You do not have to pay estimated taxes if your employers withholds enough money to cover your current year’s tax due.
How Much Estimated Taxes Do I need to Pay?
1. When you have relatively regular income
If you’re self-employed and you have relatively steady income or it’s easy to estimate your income, you can calculate how much you owe by using the worksheet of the IRS Form 1040-ES or your finance management software.
2. When you have irregular income
If it’s difficult to estimate how much money you will make this year, the easiest way to deal with estimated taxes is to pay the same amount as the last year’s tax bill. This is called “safe harbor rule“. You can avoid underpayment penalty as long as you pay 100% the last year’s tax liability.
When Do I have pay Estimated Taxes?
Estimated taxes are due four times per year:
If these days fall on a weekend or holiday, the due date is the following business day. If you do not pay enough tax by the due date of each payment period, you may be charged a penalty even if you are due a refund when you file your income tax return.
How Much Should I Pay Per Installment?
Usually you’re expected to make your estimated tax payments in four equal installments. If it’s tricky because your business is seasonal or your income is uneven every month, you can annualize your income by using the IRS Form 2210. With this form, you can avoid or lower the penalty of underpayment of estimated taxes. Another way to avoid the penalty is to go with safe harbor rule when it’s hard to make equal installments.
How Much Underpayment Penalty Will I Owe If I Don’t Pay Enough Estimated Taxes?
If you don’t pay estimated taxes on time or don’t pay enough estimated taxes, you may have to pay a penalty for underpayment of estimated taxes. For example, your tax due for this year is $15,000 and you’ve only paid $12,000 for this year’s estimated taxes, you are $1,500 short of the 90% of the threshold, $13,500. In this case, the IRS will access a penalty on $1,500.
The amount of the penalty is based on the general underpayment interest rate under IRC Section 6621.