Not sure what exactly estimated taxes are or if you need to pay them? Don’t worry, you’re not alone! We’ll do our best to clear up the confusion.
Who Typically Owes Estimated Taxes?
Income taxes in the US are a pay-as-you-go system, meaning you are required to pay taxes on your income throughout the year (in quarterly installments) rather than paying all at once when you file on April 15th. If you don't, then you will be charges penalties and interest!
You probably won’t owe estimated taxes if:
You may owe estimated taxes if you have income from sources that do not withhold taxes, such as the following situations:
You are self-employed (net income above $3,000)
You receive income from interest, dividends, or capital gains
You own rental properties
You receive income from a partnership, S-corp or other business interests
Generally, if you are only making a few thousand dollars from the above sources you probably won't have to pay estimated taxes. Self-employment is usually the biggest risk as you must pay 15.3% in self-employment taxes and regular income taxes, which can quickly push your tax bill to $1,000 - the point at which you need to make estimated payments or face penalties and interest. If you receive income from any sources that do not withhold taxes, read on to figure out if you need to be making estimated tax payments.
Do You Owe Estimated Taxes? The Quick Check
First, dig out your 2016 tax return and find your total tax (line 63 of Form 1040; line 39 of Form 1040). If your total tax for the last full tax year was $0 or you weren’t required to file a return, you don’t need to worry about making estimated tax payments in the current tax year. Hooray! However, make sure to track your tax liability throughout the year so you have enough to pay your bill come April 15th.
If your prior year’s return doesn’t meet these tests, answer the following questions:
1. Will you owe at least $1,000 in tax when you file your current year’s return?
2. Will your withholdings and refundable tax credits be less than the smaller of the following two?
90% of the total tax shown on your current year’s return
100% of the total tax shown on your prior year’s return (110% if your AGI is $150,000 or above; $75,000 for married filing separately)
If you answer yes to both 1) and 2), then you should make estimated tax payments in the current year. There are some additional caveats to consider in special circumstances, but in general these rules should apply in most situations.
Okay, You Need to Make Estimated Tax Payments. Now What?
First, try to suppress the joy of becoming the newest member of this exclusive club. After you have accomplished that, start figuring out how much you'll need to pay each quarter.
Safe Harbor Method – The Easy Option
The easiest way to calculate your estimated taxes is the Safe Harbor Method. This rule states that if you pay 100% of the total tax shown on your prior year’s tax return (110% for high- income earners), you will not be penalized even if you still owe taxes when you file. The Safe Harbor Method is a good option if you expect to earn more money this year than last year or your income is very unpredictable. However, if there is a decent chance you could make less or you qualify for sizable tax deductions in the current year, you may end up overpaying. People love tax refunds, but it if you get large refunds at the end of each year you are essentially lending the IRS your money until April 15th. This doesn’t seem as appealing? Read on below for more options:
Estimating Current Year Tax Liability – The Less Easy Option
If your earnings are somewhat predictable, you expect some sizable new tax deductions or there is a good chance you may make less money than last year, estimating your current year tax liability may be the best method. The IRS Form 1040-ES and the handy Estimated Tax Worksheet are designed to help you do this.
Don’t worry, I can vouch, the worksheet is as fun as it looks! Special note for self-employed individuals: make sure to calculate your self-employment tax deduction using the worksheet provided in this same publication. Once you have your estimated tax liability, make sure to pay at least 90% of it in timely quarterly payments by the due dates shown below.
Self-Employment “Rule of Thumb”
If you are self-employed, the general rule of thumb is setting aside 30% of your income (profits) for estimated taxes. This figure can be accurate for some taxpayers, but it depends on your specific situation and does not protect you from underpayment penalties if it isn’t accurate. The other risk is that you may end up overpaying depending on your circumstances.
When and How Do I Give My Money to the IRS? (Never thought I’d say that…)
You’ve made it this far, we’re almost there!
2017 quarterly due dates for estimated tax payments:
4/18/17 (based on January – March 2017 income)
6/15/17 (based on April and May 2017 income)
9/15/17 (based on June – August 2017 income)
1/16/18 (based on Sept – December 2017 income)
The IRS prefers four equal quarterly payments, but if your income is uneven throughout the year you can vary your payment amounts by using Schedule AI in Form 2210. This gets a little trickier, so the details will have to wait for another blog post. I bet you can’t wait!
Last of all, where should you send your payments? The easiest way to send money to the IRS is to pay online. Do you prefer snail mail? Then look to Form 1040-ES for the appropriate mailing address and payment voucher. We also suggest sending your payment at the Post Office via Certified Mail Return Receipt. This way you’ll have a stamped receipt mailed back to you to keep in your records as proof that you mailed the payment.
Feeling Overwhelmed or Have No Appetite for This Topic?
It’s hard to believe, but we enjoy this work. We’d be happy to assist with calculating your estimated tax payments and/or offering any tax planning services to help you navigate this confusing part of the tax world and minimize your tax bill. Schedule your free consultation today!