Do you have income from sources that don’t automatically withhold taxes? This might be income from investments, rentals, self-employment, or payments for services performed as a contractor. The IRS (and many states) prefer that you pay your taxes as you earn the money, so you may need to make quarterly estimated tax payments. If you don’t pay in enough throughout the year, you may be subject to underpayment interest and penalties.
Who needs to make estimated tax payments
If you expect to owe more than $1,000 in additional taxes when you file your tax return, you’ll need to make estimated payments, or you may be subject to interest and penalties. But if you had no Federal tax liability last year, and you’re a US citizen, you’ll be off the hook for those underpayment penalties if you don’t make any estimated payments.
Note that what we mean by tax liability is the total tax on your tax return — usually on line 63 of your Form 1040 — right above the section on payments. It’s not the additional tax you owed when you filed your return. If you have self-employment income, your estimated payments will need to cover your self-employment taxes.
How to calculate the amounts
The IRS has safe harbor methods for calculating your estimated tax payments. If you follow these methods, you won’t be subject to additional interest and penalties, even if you still owe tax when you file your return.
If your adjusted gross income (AGI) was less than $150,000 last year, then you’ll need to make quarterly estimated payments that total the smaller of 100% of your tax liability from last year or 90% of what you expect to owe this year. If your adjusted gross income was over $150,000 last year, then you’ll have to pay in 110% of the tax you owed last year.
The $150,000 threshold applies to couples filing married filing jointly and to single filers. But if you file as married filing separately, the threshold drops to $75,000.
You can subtract any Federal taxes that are withheld from other sources such as salaries or retirement benefits from your estimated tax payments. And if you had an overpayment last year that you applied to this year, you can subtract that as well. Remember, the goal is to get total payments to the IRS that equal your target number, either 100% of what you owed last year or 90% of what you expect to owe this year.
Here’s an example of how that works
Joe and Shirley had combined AGI last year of $144,000. This means they need to pay in 100% of last year’s tax liability. Joe has wages from a job. Shirley has self-employment income.
On last year’s 1040, their total tax liability was $42,000. This means their total payments — withholding and estimated tax payments — have to equal at least $42,000. Joe expects to have $32,000 in Federal tax withheld from his paychecks this year, so they need to make estimated tax payments totaling $10,000, or four payments of $2,500.
When to make payments
You’ll make payments on a quarterly basis, due on these dates:
First Quarter — April 15
Second Quarter — June 15
Third Quarter — September 15
Fourth Quarter — January 15
Extra withholding from your salary can help avoid penalties
The IRS calculates penalties and interest on a quarterly basis. Tax that’s withheld from wages is treated as if it were paid in evenly through the year. This means that if you haven’t paid in enough tax to meet your target amount, you can make up for it by having extra tax withheld from your paycheck. Some S-corporation shareholders even pay themselves an extra year-end bonus that’s just taxes.
If you have income from other states, you may need to make estimated tax payments to those states as well. The rules vary from state to state, so contact our office for help with this.
Many people prefer to pay the IRS as little as possible, so they pay in 90% of their current year liability. This means tracking your income carefully during the year. You may want to use this method if your tax situation changes drastically from year to year.
How to pay
You can write a check and mail it with a 1040-ES voucher. Make sure you write your social security number and the tax year on your check to make sure the IRS credits it correctly. You can also enroll in the Electronic Federal Tax Payment System (EFTPS) and make your payments electronically.
Do you have questions about estimated tax payments? We can do an analysis of your income and required payments by quarter or at year-end. Call our office at 561-624-2118 and we’ll set you up with the right payments for your situation.
Schanel & Associates is a CPA firm specializing in accounting, tax, business valuation and litigation support serving Palm Beach, Martin and St. Lucie Counties and beyond since 1993. Our CPAs and accounting professionals work with individuals, businesses, estates and trusts to provide everything you need under one roof. For more information, contact us today at 561-624-2118. Glenn Schanel is the founding Principal of Schanel and Associates. Glenn Schanel is a CPA with over three decades of experience helping people and organizations manage, make sense of and benefit from their finances. He oversees areas that include auditing, accounting, tax, business valuation, forensic accounting, litigation support and other consulting services to both business and individual clients.