Paying taxes is a necessity every U.S. taxpayer faces. For most, withholding takes care of it seamlessly. But for over 12 million filers, estimated taxes are a fact of life. This guide covers key points on estimated tax obligations, calculating and paying estimated tax, and avoiding penalties.
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Who Needs to Pay Estimated Taxes?
The IRS requires estimated tax payments from individuals who expect to owe $1,000 or more when their return is filed, beyond what's covered through withholding. Situations causing under-withholding and the need for estimated tax include:
Self-employment income
Investment income
Rental income
Uneven income through the year
Corporations generally make estimated payments if they expect to owe $500 or more when their return is filed.
How to Calculate Estimated Tax
To calculate an estimated tax owed, start by tallying up all sources of income expected for the year, including wages, self-employment earnings, interest, dividends, and any other relevant income. Then, subtract eligible deductions and credits that apply. This adjusted income provides a baseline for estimating the tax owed. Using the current tax rates and brackets provided by the IRS, calculate the tax due on this estimated income.
Factor in any taxes already withheld from paychecks or other payments made toward taxes during the year. Based on this calculation, determine the total estimated tax obligation for the year. Quarterly, review and adjust these estimates as income or deductions change to ensure payments align with the actual tax liability. This meticulous approach allows for a more accurate estimation of tax owed throughout the year, reducing the likelihood of a significant tax bill at the year's end.
When figuring current year's estimated tax, it may help to use your income deductions and credits from the prior year as a baseline. Referring to your prior year's return can provide a useful starting point. You can use the worksheet in Form 1040-ES to calculate estimated tax.
Here at United Tax we created a free tool to enable anyone to get an accurate calculation for their year-end tax liability. By answering a few short questions you can get a clear picture for how much taxes you will owe, and some insights on how to reduce your taxable earnings.
Using Safe Harbor Rules To Avoid Penalties
If you don't pay enough through withholding and estimated payments during the year, you may be charged a penalty even if you are due a refund when you file your tax return.
Safe harbor rules help taxpayers avoid penalties for underpayment of taxes. Most taxpayers can escape penalties if they owe less than $1,000 in taxes after accounting for withholding and credits, or if they've paid at least 90% of the taxes due for the current year, or 100% of the prior year's tax, whichever amount is smaller. However, for those with an Adjusted Gross Income (AGI) exceeding $150,000 ($75,000 for married filing separately), the rules change slightly. In this case, they must pay either 90% of the current year's tax or 110% of the prior year's tax to sidestep penalties.
If your income is received unevenly during the year, you may be able to avoid the penalty by annualizing your income and making unequal payments. Use Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts or Form 2220, Underpayment of Estimated Tax by Corporations, to see if you owe a penalty.
The penalty may also be waived if:
The failure to make estimated payments was due to casualty, disaster or other unusual circumstances
You retired after reaching age 62 or became disabled during the tax year for which estimated payments were required or in the preceding tax year and the underpayment was due to reasonable cause and not willful neglect.
Estimating Taxes Vs. Safe Harbor
While both methods serve as approximations for tax payments, they differ in their precision and implications. The meticulous calculation of income and deductions offers a more accurate estimation of tax liabilities, reducing the potential for a tax bill at the year's end. This method ensures a closer alignment between the estimated payments made throughout the year and the actual tax owed, providing a clearer picture of one's financial obligations.
On the other hand, the safe harbor method, while effective in avoiding penalties, leaves more room for potential tax liability. It sets thresholds to prevent penalties but doesn't guarantee that the estimated payments will cover the entirety of the tax owed. Taxpayers relying solely on safe harbor guidelines might find themselves in a situation where they've met the requirements to avoid penalties but still owe additional taxes based on their income.
When Estimated Tax Payments Are Due
Estimated taxes are divided into four payment periods. Each has a specific payment due date:
January 1st to March 31st, payment due April 15th
April 1st to May 31st, payment due June 15th
June 1st to August 31st, payment due September 15th
September 1st to December 31st, payment due January 15th of the following year
If the due date falls on a weekend or legal holiday, the payment will be on time if made on the next day that isn't a Saturday, Sunday or legal holiday.
How to Pay Estimated Taxes
You can pay estimated taxes by mail with vouchers, or online through IRS Direct Pay, your bank, or from your mobile device using the IRS2Go app.
Corporations must deposit payments using the Electronic Federal Tax Payment System (EFTPS). Most can make EFTPS deposits online.
The Electronic Federal Tax Payment System (EFTPS) is the easiest way for individuals too. With EFTPS you can see your payment history and other tax records. Go to EFTPS.gov ‐ Payments to view all the options.
Key Takeaways on Estimated Taxes
Know if you are obligated to make estimated tax payments based on expected tax liability minus withholding
Use prior year returns and expected changes as a starting point in calculating estimated tax
Pay in four installments on the specified due dates
Make payments by mail, online, or via mobile app
Consider if special rules for farmers, fishermen, etc. apply
Review Form 2210 or 2220 to see if estimated tax penalty applies or can be waived
hopefully these insights help provide greater clarity on estimated taxes. Determining what you may owe and planning estimated tax payments accordingly is an important part of staying current and avoiding penalties. Additionally, you can use United Tax's free tax projection tool to get a customized tax projection where you will get an estimate for how much taxes you may owe and some insights on how to reduce your taxable earnings. Wishing you the very best this tax season!
