How to Do Estimated Taxes: A Step-by-Step Overview

Freelancers, self-employed individuals, and those with significant income outside traditional employment must make estimated tax payments. Unlike employees whose taxes are withheld, these taxpayers must calculate and submit payments throughout the year to avoid a large bill at tax time.

Calculating Payment Amounts

Estimating tax payments begins with projecting total taxable income, including self-employment earnings, rental income, and investment gains. Deductions and credits should then be factored in. The IRS provides Form 1040-ES, which includes a worksheet for these calculations.

The U.S. tax system is progressive, with federal tax brackets ranging from 10% to 37% in 2024. Self-employed individuals must also account for self-employment tax, which covers Social Security and Medicare. This tax is 15.3% on net earnings up to $168,600, with a portion deductible when calculating adjusted gross income.

State and local taxes may also require estimated payments. California, for instance, has different due dates than the federal schedule, while New York imposes penalties for underpayment even if the full amount is paid by year-end. Overlooking these obligations can lead to unexpected liabilities.

Payment Schedules

Estimated tax payments are due in four installments: April 15, June 15, September 15, and January 15 of the following year. If a due date falls on a weekend or holiday, the deadline moves to the next business day.

Each payment should reflect income earned up to that point. Taxpayers with fluctuating earnings may need to adjust calculations each quarter rather than dividing their estimated liability into equal parts. The IRS allows for the annualized income installment method, which bases payments on actual earnings per period rather than a fixed projection. This benefits those with seasonal or irregular income.

Failing to pay on time can lead to penalties, even if the total tax liability is covered by year-end. Penalties are based on the amount owed and the number of days past the deadline, with interest rates adjusted quarterly. As of 2024, the penalty interest rate for individuals is 8% per year, compounded daily. Some taxpayers may qualify for a waiver if a missed payment was due to unforeseen circumstances, such as a natural disaster or medical emergency.

Methods of Sending Payment

The IRS offers multiple payment options. Many prefer the Electronic Federal Tax Payment System (EFTPS), a free service that enables direct transfers from a bank account. EFTPS requires enrollment, which can take several days, so first-time users should plan ahead. Payments can be scheduled in advance to avoid missing deadlines.

For a quicker method, IRS Direct Pay allows one-time payments from a checking or savings account without registration. Transactions typically process within one to two business days, with immediate confirmation. Unlike EFTPS, Direct Pay does not support scheduling future payments, requiring manual submission each quarter.

Credit and debit card payments are also available but come with processing fees. As of 2024, these fees range from 1.87% to 1.98% for credit cards and a flat rate of about $2.50 for debit cards. While convenient, the added cost makes this method less appealing unless a taxpayer is leveraging credit card rewards or managing cash flow.

Adjusting Contributions

Taxpayers with fluctuating income may need to adjust estimated tax payments to avoid overpaying or underpaying. The IRS allows modifications each quarter based on actual earnings, which is useful for freelancers, business owners, and investors with unpredictable income.

A sudden income increase, such as a large contract payment or investment gain, may require recalculating estimated taxes before the next due date to prevent a surprise tax bill and potential penalties. This is particularly relevant for those subject to the Net Investment Income Tax (NIIT), which applies an additional 3.8% tax on certain investment income if modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly. Factoring in these liabilities early helps taxpayers allocate funds appropriately.

Recordkeeping

Accurate recordkeeping ensures compliance and simplifies tax filing. The IRS does not send reminders beyond the confirmation at the time of payment, so taxpayers must track their contributions to avoid discrepancies when filing their return. Keeping records also helps in the event of an audit or income adjustments.

Bank statements, IRS payment confirmations, and copies of Form 1040-ES vouchers should be retained for at least three years, the standard period during which the IRS can audit a return. Digital tools like accounting software or spreadsheets can help organize payment dates, amounts, and methods used. Consolidating all records in one place prevents errors and ensures all payments are properly accounted for when reconciling tax liabilities.

Potential Penalties for Underpayment

Failing to pay enough in estimated taxes can lead to penalties, even if the full amount is paid when filing an annual return. The IRS generally expects taxpayers to cover at least 90% of their total tax liability through estimated payments or withholding. Alternatively, those who pay at least 100% of their prior year’s tax liability—110% for higher earners with adjusted gross income exceeding $150,000—can avoid penalties under the safe harbor rule.

If payments fall short, the IRS calculates a penalty based on the underpaid amount and the length of time it remains outstanding. The penalty is determined using the federal short-term interest rate plus three percentage points, which is adjusted quarterly. As of 2024, this rate is 8% annually, compounded daily. Taxpayers who can show that underpayment resulted from unforeseen circumstances, such as a natural disaster or medical emergency, may request a waiver by filing Form 2210. Using the annualized income installment method can also help reduce or eliminate penalties by aligning payments with actual earnings.