If you run a business or earn income outside of traditional W-2 employment, chances are you need to pay estimated taxes. But estimated payments can be confusing, especially determining how much you should set aside and pay to the IRS each quarter.
Get up to speed on everything you need to know as a small business owner with this comprehensive guide to estimated tax.
In this article we will cover:
Who Needs to Pay Estimated Taxes?
If you have income that is not subject to tax withholding, you typically need to pay estimated taxes. This includes:
Self-employment income from running a business, freelancing, side jobs, etc.
1099 income from contract work, consulting, and miscellaneous payments
Rental property income
Investment income like interest, dividends, and capital gains
Retirement account withdrawals
Alimony
Any other taxable income where taxes are not withheld
You may need to pay estimated taxes if you also have W-2 income. Generally if you expect to owe more than $1,000 in taxes for income that is not subject to withholding, estimated payments are required.
Pro Tip: Use past tax returns as a guide. If you owed taxes on non-withheld income, chances are you’ll owe again.
What Are the Payment Deadlines?
Estimated taxes are paid in four equal installments on the following dates:
April 15th
June 15th
September 15th
January 15th of the following year
For example, for the 2022 tax year, payments would be due on 4/15/22, 6/15/22, 9/15/22 and 1/15/23.
Pro Tip: If a deadline falls on a weekend or holiday, payment can be made on the next business day.
How Much Should I Set Aside?
Determining how much to pay for estimated taxes takes a bit of planning and forecasting. Ideally you will pay in 90-100% of your expected total tax liability for the year. There are three ways to calculate each quarterly payment:
Pay 100% of your prior year’s total tax liability, divided by 4. This is the easiest method but may result in over- or under-payment if your income changes.
Pay 90% of your expected current year tax liability, divided by 4. This requires estimating your income and expenses to project your total tax obligation.
Use the annualized installment method to base each payment on your actual income and liability for that quarter. This is the most precise method but requires meticulous accounting.
Most self-employed individuals use method 1 or 2 for simplicity. But consult a tax professional to determine the best approach based on your particular financial situation.
Pro Tip: Make your best estimate for each quarterly payment, then do a "true up" when you file your tax return.
What Happens if I Miss a Payment?
It’s important to stick to the quarterly due dates as much as possible. If you fail to make payments on time, you may be subject to penalties and interest on taxes owed.
However, the IRS does provide some flexibility:
You can avoid penalties if payments equal at least 90% of the current year liability or 100% of the prior year.
If owing less than $1,000, penalties may be waived even if 90% threshold is not met.
Reasonable cause may allow abatement of penalties for special circumstances.
Pro Tip: File Form 2210 with your tax return to calculate and report any penalty for underpayment.
Dealing with Financial Hardship
If facing financial difficulty, still make every effort to pay what you can. Partial or prorated payments are better than none at all. You can request an extension of time to pay if unable to remit in full. Once you file your taxes, the IRS will typically grant 120 days to pay before assessing penalties or fees. Just be sure to pay as much as possible upfront before requesting an extension.
Should I Make Estimated Payments if I Owe Taxes?
Some self-employed taxpayers actually overpay their estimated taxes substantially during the year. This essentially gives the IRS an interest free loan until you file your tax return and get a refund. It’s usually preferable to pay only the 90-100% of actual liability. But there are some benefits to overpaying:
Peace of mind knowing you won’t face underpayment penalties
Forcing yourself to set aside money for taxes helps with financial discipline
Could increase current year business deductions
Use other strategies like retirement plans to reduce taxable income rather than overpaying estimates. But if you prefer overpaying for personal reasons, it’s perfectly acceptable as long as you understand the tradeoffs.
Pro Tip: Adjust your W-4 withholdings on a second job or spouse’s income to account for additional tax liability from self-employment earnings.
What if You Receive a Large, Irregular Payment?
If you occasionally receive large lump sum payments like bonuses, lawsuit settlements, or capital gain distributions, you may need to account for these in your estimated payments to avoid penalties. Options include:
Increasing payment for the quarter it is received to account for the extra tax liability
Using the annualized installment method to calculate each payment
Waiting to make the entire payment for the irregular income with your tax return filing
Paying your standard estimate amount each quarter and accounting for the extra liability later
Work closely with your CPA to determine the best course of action based on the size and timing of any unusually large payments.
Estimated Tax Payment FAQs
Can I deduct estimated tax payments for my business?
Yes, estimated tax payments are deductible as ordinary business expenses.
What if my income decreases substantially?
File a new Form W-4V to decrease or eliminate future estimated payments.
Do I need to make estimated payments for state taxes too?
In most cases yes, if you owe state income taxes. Check with your state.
Can I apply an overpayment from last year towards this year?
Yes, you can credit all or part of a prior year refund to this year's estimates.
What records should I keep related to estimated taxes?
Keep copies of all payments, Form 1040-ES vouchers, and proof the payments cleared.
Is there a penalty for overpaying estimated taxes?
No, there is no penalty for overpaying. You will receive a refund after filing.
Conclusion and Next Steps
Estimated tax payments are critical for self-employed business owners and investors. Failure to pay enough during the year can lead to penalties, so taking time to understand requirements and plan payments is crucial.
As you navigate estimated taxes for your business, the tax professionals at UnitedTax.Ai are here to help. Get in touch today to have us prepare an estimated tax forecast based on your projected income and expenses. We can also help adjust W-4 withholdings, make sure you hit all quarterly deadlines, and ensure no penalties at year end. Contact us to discuss your specific situation and get proactive with your estimated taxes!
