What are Estimated Tax Payments: Definition, How & When to Pay

What are Estimated Tax Payments: Definition, How & When to Pay
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If you’re self-employed, you don’t have taxes coming out of each paycheck. But that doesn’t relieve you from the obligation of paying taxes throughout the year. Self-employed taxpayers are expected to make estimated tax payments, paying one-fourth of their estimated taxes owed each quarter, to avoid penalties at tax time.

What Are Estimated Tax Payments?

Salaried and hourly employees typically have taxes taken out of each paycheck. For those who are self-employed, though, income tax isn’t automatically paid. But if you earn $400 on your own, even in a side gig, you’re required to complete and file Schedule SE, which calculates your earnings for the year and determines how much you owe in taxes.

But you can’t just wait until April to pay Uncle Sam. The IRS expects you to pay taxes throughout the year if you earn above a certain amount. The IRS suggests that if you expect to owe $1,000 or more when you file your taxes for the year, you should divide the amount up and pay it throughout the year.

Who Should Pay Estimated Taxes?

Unless taxes are being taken out on your income, or you make less than $400, you’ll bear the responsibility of paying your self-employment tax each year. Individuals and businesses are responsible for paying estimated taxes if they expect to owe $1,000 or more in taxes for the tax year. Corporations are expected to pay them if they will owe $500 or more.

To determine whether you need to pay estimated taxes, use the Estimated Tax on Form 1040-ES. Here, you’ll input your estimated gross income for the year and a ballpark figure for the various deductions you plan to take. The worksheet walks you through calculating the tax you can expect to owe. Play with these numbers, adjusting your income and expenses to determine if you’re safe to skip estimated taxes this year.

Rules for Certain Workers

In addition to owing $1,000 or more, the IRS also expects you to pay estimated taxes if your withholding and refundable credits are either 90 percent of the tax to be shown on your 2020 tax return or 100 percent of the tax shown on your 2019 tax return, if it covered all 12 months. If two-thirds or more of your income came from farming or fishing, though, you’ll need to pay it if 66-2/3 percent of your taxes are withholding and refundable credits.

Household workers like housekeepers, maids, babysitters and gardeners may also have to complete Form 1040-ES and pay estimated taxes. If your employer paid you cash wages of more than $2,200, the IRS requires that Social Security taxes be remitted on your behalf. Employers are not required to withhold federal income tax on you, though, so it’s important to keep an eye on this. You should also double-check to make sure your employer is withholding Social Security and Medicare to avoid an unpleasant surprise at tax time.

How to Pay Quarterly Taxes

To pay quarterly taxes, you’ll use the Estimated Tax Worksheet to arrive at an estimated tax liability and divide it by four quarterly payments. You’ll find payment vouchers just below that worksheet that you can complete and mail into the IRS with your check or money order. Make the payment payable to the United States Treasury and make sure you write the primary Social Security number used when you file taxes on your payment.

You can also pay your estimated taxes online. This is the best way to make sure your payment gets through before the deadline. You can transfer the money directly from your bank account or use a credit card, the latter of which costs a convenience fee. To pay your quarterly payments online, go to IRS.gov/payments.

When to Pay Estimated Taxes

Estimated taxes come with a ​due date attached to each payment. These are detailed each year on Form 1040-ES, but they usually fall on January 15, April 15, June 15 and September 15. The form not only includes your due dates, but also a form that you can use to log the date you paid, the check or confirmation number and the amount paid.

It's important you not only make sure your estimated tax payments arrive before the due date but also be able to show that they did if it’s questioned later. Paying your quarterly tax payments late can lead to a penalty similar to the penalty you’ll be charged if you underpay your taxes.

Penalties for Underpayment

The IRS can charge penalties for a variety of reasons, including paying your taxes late, failing to pay estimated taxes and paying estimated tax payments late. Filing an extension on your tax return does not remove your obligation to pay the taxes you owe by the due date.

The IRS charges a penalty of 5 percent of the amount of the unpaid tax, charged each month that the payment is late with a limit of five months. For late estimated payments, the IRS calculates the penalty for each late installment separately. First, they’ll tally the number of days it was late, then multiply that by the interest rate for that particular installment period.

Removing Late Payment Penalties

There are some circumstances when the IRS may forgive those late fees. For estimated payments, the IRS may let you pay unevenly if your income ebbs and flows throughout the tax year. The agency directs you to Form 2210 to calculate uneven payments in accordance with your income levels during various quarters.

If you were unable to meet your tax obligations throughout the year, you may be able to apply for Penalty Relief. First, contact the IRS to make sure the penalty you’re being charged is accurate. If so, review the IRS’s penalty relief options. They are:

  • Reasonable cause: The IRS will determine if you used every effort to pay your taxes on time and were still unable to do so.
  • Administrative waiver and first-time penalty abatement: If this is your first tax return, or you have had three consecutive years of paying on time prior, you may be able to get a waiver of penalties. You’ll likely also have to pay, or arrange to pay, the taxes due.
  • Statutory exception: If your late payment is due to faulty information from the IRS, you may be eligible for a penalty waiver.

Overestimating Versus Underestimating

As with taxes deducted from your paycheck, you may be tempted to overpay taxes during the year “just to be safe.” If you pay in too little, you risk not only penalties for underpayment but also a big tax bill in April. By overshooting the amount you’re likely to owe, you’ll have a little padding if you make more than you thought.

Although it’s always nice to not have a hefty tax liability, it’s important to keep in mind that when you turn this money over to the IRS, you won’t get it back until you file your taxes the next year. That’s money you could put into an interest-bearing account, earning interest on it during that timeframe. Overestimating your taxes will cost you.

Estimated Taxes for Side Gigs

Some workers earn both employer-provided and self-employed income. If you earn money from your side gig, the first question will be whether that amount is $400 or more. If the answer to that is “yes,” you’ll need to determine whether or not your earnings will require you to pay $1,000 or more in taxes for the tax year.

But if you have an employer taking out taxes on your earnings, you have another option. You can shift some of the year's tax burden onto those withdrawals. Instead of relying on estimated taxes, simply have your employer take more out of each check and submit it to the IRS. This will offset the untaxed amount you’re making on the side.

Affording Estimated Taxes

If you’re self-employed, you likely need every dime of the money you’re making. But just as your employer would withhold part of your paycheck for taxes, you should be setting money aside from each payment for taxes. A full 15.3 percent of your earnings will go to self-employment tax, which includes your Social Security and Medicare. This doesn’t include federal and state income taxes you’ll owe.

If you have steady payments, make a point of pulling out a fixed amount on a regular basis for taxes. Financial expert Dave Ramsey recommends setting aside 25 to 30 percent of every dollar you make. If you put this in a special account, you’ll have it in place when it’s time to pay quarterly taxes.

Inability to Pay Estimated Taxes

There may be times when you’re simply unable to submit a check for hundreds or thousands of dollars to the IRS. It’s imperative that you submit each payment on time to the best of your ability. If, however, you find yourself in a pinch, send the money as soon as you can after the deadline. This will help minimize any penalties.

Some make the mistake of assuming that quarterly taxes are flexible. When you file your taxes, the IRS will note the four payments you made during the year and make sure they were submitted in a timely fashion. If they were late and you face penalties, you may be able to request those penalties be waived.

Reducing Your Tax Burden

Filing your income tax return as a self-employed professional means reducing the amount of taxable income each year. One of the best ways to do this is by setting money aside for your retirement. In 2020, self-employed taxpayers can invest up to 25 percent of your earnings, with a limit of $57,000, to a simplified employee pension plan each year.

You’ll also need to itemize deductions if you’re claiming self-employment income. This means tracking your expenses throughout the year and tallying them up to put them into categories on your tax forms. Here are some of the expenses you can claim if you’re self-employed:

  • Marketing expenses
  • Cellphone costs
  • Business use of personal vehicles
  • Home office expenses
  • Computer equipment and peripherals
  • Travel expenses
  • Office supplies
  • Training and memberships

For some expenses, such as cellphone costs, you’ll need to calculate the percentage you use it for business versus personal and only claim the business portion.

Estimated taxes add another administrative task to a self-employed professional’s to-do list. However, once you’ve calculated how much you owe for the year, you should be able to set it up on your calendar and pay it routinely as scheduled. If you use a tax preparer or accountant, request that this be calculated when doing your taxes for the current year to get an expert opinion on how much you should pay throughout the year.