Calculating Your Estimated Tax Payments
Go beyond the basics with a structured approach to calculating what you owe, providing a clear framework for handling income that is steady or variable.
Estimated taxes are payments made throughout the year to cover income tax on earnings not subject to withholding, such as from self-employment, interest, or dividends. The purpose of this system is to pay tax as you earn income, similar to how taxes are withheld from an employee’s paycheck.
Determining Your Requirement to Pay
The need to pay estimated taxes is based on financial thresholds set by the Internal Revenue Service (IRS). You must make these payments if you expect to owe at least $1,000 in federal tax for the year after accounting for all withholdings and refundable credits.
This requirement commonly affects sole proprietors, partners, and S corporation shareholders who receive business income directly. It also applies to individuals with significant non-wage income, such as from investments or the sale of assets.
Information and Forms for Calculation
To calculate your estimated tax, you will need Form 1040-ES, Estimated Tax for Individuals. This document contains a worksheet to guide you through the calculation process.
This involves estimating your adjusted gross income (AGI), which is your total income less certain deductions. You will also need to determine whether you will take the standard deduction or itemize deductions. Gather information on any tax credits you expect to claim and the total federal income tax you expect to have withheld from other income sources.
Once you have these figures, the Estimated Tax Worksheet helps determine your total expected tax liability. The worksheet guides you in calculating your total estimated tax, including self-employment tax, and then subtracts your expected withholding and credits. The result is the net estimated tax you must pay.
Methods for Calculating Your Payments
The most straightforward approach is the Regular Method. This involves dividing your total estimated tax due for the year by four and making equal payments by each of the four quarterly due dates.
The Annualized Income Installment Method is available for individuals whose income is not received evenly throughout the year, such as for seasonal business owners. This method allows you to adjust your payment amount for each period based on the income you actually earned in that specific quarter.
To use this method, you must complete Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, and attach it to your tax return. This approach requires more detailed record-keeping but can prevent overpaying in slow periods and facing a penalty for underpaying when your income is concentrated later in the year.
How to Make Estimated Tax Payments
There are several ways to submit your payment to the IRS. The traditional method involves mailing a check or money order with a payment voucher from Form 1040-ES.
For electronic payments, IRS Direct Pay allows you to pay directly from a checking or savings account at no cost. Another option is the Electronic Federal Tax Payment System (EFTPS), a free online service that allows for scheduling payments in advance. You can also pay by debit card, credit card, or digital wallet, though third-party processing fees may apply.
Payments are due in four installments. If a due date falls on a weekend or holiday, the payment is due the next business day. The deadlines cover the following periods:
- April 15: For income earned January 1 – March 31
- June 15: For income earned April 1 – May 31
- September 15: For income earned June 1 – August 31
- January 15 (of the next year): For income earned September 1 – December 31
Understanding Underpayment Penalties
Failing to pay enough tax throughout the year via withholding or estimated payments can result in an underpayment penalty. The IRS calculates this penalty based on the amount of the underpayment, the period it remained unpaid, and the applicable interest rate.
To avoid this penalty, the IRS provides “safe harbor” rules. The primary way to meet the safe harbor is to pay at least 90% of the tax you owe for the current year.
An alternative safe harbor is to pay 100% of the tax shown on your prior year’s tax return. For taxpayers with an AGI over $150,000 ($75,000 if married filing separately), this threshold increases to 110% of the prior year’s tax. Meeting one of these rules protects you from the penalty, even if you owe more than $1,000 when you file.