Estimated Tax Payments – Do They Apply to You?

There are two ways to make income tax payments to the IRS throughout the year: through the withholding amount on your paycheck, and through making estimated tax payments. If you have ever wondered about estimated tax payments, this article will explain what they are, if you need to make them, and how to make them if they are required for your tax situation.

Although you may never have had to worry about them before, a change in your income/situation may put you in a position of needing to make estimated tax payments during the year. If you fail to make estimated payments (and therefore fail to pay taxes on your income as you earn it), you may be in for a nasty surprise come tax time: a hefty tax bill along with an unwelcome penalty from the IRS.

Who is required to pay estimated tax payments?

In general, you are required to make quarterly estimated tax payments if both of the following apply:

  1. You expect to owe at least $1,000 in federal tax after subtracting federal tax withholding and credits, and
  2. You expect your federal withholding and credits to be less than the smaller of:
  • 90 percent of the tax to be shown on your current year federal return, or
  • 100 percent of the tax shown on your prior year federal return

There are additional rules for some type of taxpayers, such as farmers and fishermen.

If you receive your main income via paycheck as an employee who receives a W-2, chances are you won’t be subject to this requirement as long as your employer is withholding the proper amounts from your paychecks. The amount withheld is determined by the information on Form W-4 that you complete when you are hired.

What if you have income, but no paycheck? What if you have lots of income in addition to your paycheck? Chances are you will need to make estimated tax payments (or adjust your withholding). Most taxpayers who are subject to making estimated tax payments are those who have a large amount of income on which there is no tax withholding, including interest, dividend, capital gains, rental/royalty, or business income.

If you receive a paycheck, you can avoid making estimated payments by increasing your W-2 withholdings enough to cover any additional tax liabilities. Make sure to double check with your employer, to ensure that the correct information is being used to calculate your tax withholdings.

If you do have additional income and you don’t get a paycheck, or you do, but you simply don’t want to withhold more from your paycheck, you will need to make estimated tax payments.

What information do I need?

In order to determine the proper amount of estimated tax payments to make, you’ll need to approximate your adjusted gross income, taxable income, taxes, credits, and other deductions. Start with your prior year return information, and make changes based on what you know will be different. Form 1040-ES, which can be found on the IRS website, includes an Estimated Tax Worksheet to help you with this process.

When are these payments due?

Estimated tax payments are generally made in four installments. Payments are due by April 15th, June 15th, September 15th, and January 15th of the next year. These dates are based on quarterly payment periods (you pay tax on income earned during each applicable quarterly period); however, notice that the payment due dates aren’t all three months apart.

As a side note, you are not required to make the final payment on January 15th if you file your current year tax return by February 1st and pay the entire balance due with your return.

Where and how do I make my quarterly estimated tax payments?

There are various ways of making estimated tax payments for the current year, including:

  • Mailing the payment in with a voucher – Form 1040-ES
  • Paying by phone or electronically via EFTPS, the Electronic Federal Tax Payment System
  • Making a payment via EFT with your prior year e-filed return
  • Remitting a payment on the IRS website (or the appropriate state tax authority website; yes, you may need to make estimated tax payments to your state). Here’s the IRS link:
  • Applying an overpayment on your prior year return towards your current year estimated tax payments

Why should I consider making estimated tax payments?

The main reason is to avoid penalties and interest on underpayments. This can happen if your income varies a lot from year to year; you can get surprised by the changes.

Penalties and interest can add up quickly. They are calculated based on the number of days you are late – so, even if you’re already behind, don’t panic! You can address the situation now and minimize the dollar amount of penalties you are hit with.

Getting on track with making proper and timely estimated tax payments may help you in the long run. Getting hit with a large tax bill on April 15th is no fun, and by breaking your tax liability down into four installment payments, you may be doing yourself a big favor in forcing yourself to set those funds aside and having them available to make your payments (while simultaneously keeping the IRS at bay).

This can also help you to avoid a “snowballing” problem in the future – if you end up with a large bill that you cannot pay all at once, and you get on a payment plan with the IRS, it can be difficult to play catch-up.

Staying on top of your estimated tax payments requires you to be more disciplined and aware of your tax responsibilities as a taxpayer and/or business owner. If you need help getting these calculated or set up, please reach out any time.