What Is an Estimated Tax Payment and Who Must Pay It?

Estimated tax is the system for paying taxes on income not subject to employer withholding. The U.S. tax system is “pay-as-you-go,” requiring you to pay tax on income as you receive it. While most employees have taxes withheld automatically via Form W-4, others must make estimated tax payments. This applies to income from sources like self-employment or investments, ensuring tax obligations are met periodically throughout the year.

Who Needs to Pay Estimated Taxes

The requirement to pay estimated taxes is triggered by financial thresholds set by the Internal Revenue Service (IRS). If you expect to owe at least $1,000 in tax for the year, after subtracting withholding and refundable credits, you will need to make these payments. This rule applies to sole proprietors, partners, and S corporation shareholders who receive income not subject to withholding. It also affects freelancers, independent contractors, and those with income from interest, dividends, rental income, or capital gains.

To avoid penalties, your total tax payments from withholding and estimated payments must meet certain criteria. These payments must equal at least 90% of your tax liability for the current year. Alternatively, you can use a “safe harbor” rule and pay 100% of the tax shown on your prior year’s tax return. This safe harbor threshold increases to 110% if your adjusted gross income (AGI) on that return was more than $150,000 ($75,000 if married filing separately).

You are exempt from making estimated tax payments if you meet three conditions:

• You had no tax liability for the prior year.
• You were a U.S. citizen or resident for the entire tax year.
• Your prior tax year covered a full 12-month period.

For W-2 employees who also have other income sources, an alternative is to increase tax withholding. This can be done by submitting a revised Form W-4 to an employer, requesting an additional amount be withheld from each paycheck.

How to Calculate Your Estimated Tax Payment

The primary tool for calculating your federal estimated tax is Form 1040-ES, Estimated Tax for Individuals. This form includes a worksheet to guide you through projecting your financial picture for the year. You will need your expected adjusted gross income (AGI), anticipated deductions, and eligible tax credits. Using your previous year’s tax return as a starting point is a helpful reference.

The calculation begins with estimating your total income for the year. You then subtract any above-the-line deductions to arrive at your expected AGI. From there, you subtract either the standard deduction or your total itemized deductions. This determines your estimated taxable income, which you use to calculate your expected income tax, and finally subtract tax credits to find your total estimated tax.

After calculating your total estimated tax using the Form 1040-ES worksheet, you divide this total by four to determine the amount of each quarterly payment. The calculation is based on one of the two methods to avoid penalties. The first method is to pay at least 90% of your current year’s tax liability, which is useful if your income changes significantly. The second is the “safe harbor” rule, which provides a clear target based on your prior year’s tax. If your income changes during the year, you can recalculate your estimated tax for the remaining quarters by completing a new worksheet.

Making Your Estimated Tax Payments

The federal tax year is divided into four payment periods, and each has a specific due date. Payments are due on April 15, June 15, September 15, and January 15 of the following year. These dates do not correspond to calendar quarters; for instance, the second payment period is only two months long.

The IRS offers several methods for submitting your estimated tax payments:

• IRS Direct Pay, which allows you to make payments directly from a checking or savings account at no cost.
• The Electronic Federal Tax Payment System (EFTPS), a free online service for scheduling payments in advance.
• Debit card, credit card, or digital wallet, though these transactions are processed by third-party payment processors that may charge a fee.

You can also pay by mail with a check or money order using the corresponding payment voucher from Form 1040-ES. Each voucher is labeled for a specific due date, so it is important to use the correct one. When paying electronically, you will receive a confirmation number for your records.

Penalties for Underpayment

Failing to pay enough tax throughout the year via withholding or estimated tax payments can lead to a penalty. An underpayment occurs if you pay less than the required amount based on the 90% rule or the prior-year safe harbor rule. The penalty is an interest charge on the amount you underpaid for the duration it was overdue.

The IRS calculates this penalty separately for each payment period. This means you could owe a penalty for an earlier quarter even if you pay enough later on to make up the difference. The penalty is figured using Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, which you attach to your tax return.

In certain situations, the IRS may waive the underpayment penalty. This can occur if you failed to make required payments because of a casualty, disaster, or other unusual circumstance. The penalty may also be waived if you retired after reaching age 62 or became disabled during the tax year, and the underpayment was due to reasonable cause.