What Is Payment on Account and How Does It Work?

Payment on account is a method for taxpayers to meet income tax liability on earnings not subject to standard withholding. This system ensures a steady flow of tax revenue to the government while helping taxpayers avoid a large, single tax bill at year-end. It applies primarily to income sources where taxes are not automatically deducted, promoting a “pay-as-you-go” approach to taxation.

Understanding Payment on Account

Payment on account refers to a system of advance tax payments made by individuals whose income is not fully subject to tax withholding. This mechanism ensures that taxpayers meet their income tax obligations incrementally throughout the year, rather than facing a substantial single payment when filing their annual return. This system primarily applies to self-employed individuals, independent contractors, and those who are partners in a business. Individuals with significant income from other untaxed sources, such as rental income, interest, or dividends not subject to backup withholding, also typically need to make these payments.

Calculating Your Payments

The Internal Revenue Service (IRS) outlines specific methods for determining the amount of each payment on account. Generally, taxpayers calculate their estimated tax liability for the current year based on their expected income, deductions, and credits. A common guideline is to pay at least 90% of the current year’s tax liability through timely payments to avoid underpayment penalties.

Alternatively, taxpayers can base their payments on their previous year’s tax liability. This “safe harbor” rule generally requires paying 100% of the prior year’s tax, or 110% if the taxpayer’s adjusted gross income (AGI) in the preceding year was over $150,000 ($75,000 for married individuals filing separately). The IRS provides Form 1040-ES, Estimated Tax for Individuals, which includes a worksheet to assist in this calculation.

Making and Adjusting Payments

Payments on account are typically made in four equal installments throughout the tax year. For a calendar year taxpayer, the common due dates are April 15, June 15, September 15, and January 15 of the following year. If any of these dates fall on a weekend or holiday, the deadline shifts to the next business day.

Taxpayers have various convenient methods to submit these payments. Options include using IRS Direct Pay, enrolling in the Electronic Federal Tax Payment System (EFTPS), or making payments via debit or credit card through an approved third-party processor. Payments can also be mailed to the IRS with a payment voucher from Form 1040-ES.

Circumstances may arise where a taxpayer’s income or deductions change significantly during the year, necessitating an adjustment to their payments. If a taxpayer anticipates a lower income for the current year than initially estimated, they can reduce their remaining payments to avoid overpaying. Conversely, if income increases, payments should be adjusted upward to prevent underpayment penalties. This adjustment can be made by recalculating the estimated tax and simply paying a different amount for subsequent installments.

The Balancing Payment

The balancing payment represents the final amount of tax due or refunded after the actual tax liability for the year has been determined and all payments on account have been credited. This amount arises because the provisional payments made throughout the year are estimates, and the actual tax owed might differ. If the total tax due for the year, as calculated on the annual tax return, exceeds the sum of the payments on account made, the difference becomes a balancing payment. Conversely, if the total payments on account exceed the actual tax liability, the taxpayer is due a refund. This final reconciliation typically occurs when the annual income tax return is filed, with any remaining tax due by the tax filing deadline, generally April 15 of the following year.