Do you need to make Quarterly Estimated Tax Payments?

Do you need to make Quarterly Estimated Tax Payments?

Here’s the What, Who, When, Why and How

What is Estimated Tax?

It’s the method used to pay tax on income that is not subject to withholding. W-2 income has taxes withheld. On the other hand, 1099 income typically has no tax withholding. Neither does rental income, or alimony, or gross receipts earned in a small business.  In these examples, no one is ‘with-holding’ or taking any taxes out of your income and sending it to the IRS for you.
Our tax system is based on the English “Pay as you go” system, by which you’re expected to pay quarterly, and will be penalized if you simply wait until next April 15th to “settle up” with the IRS on your income tax.

Who Needs to Pay Estimated Tax?

The basic rule is that you must make quarterly payments if you expect to owe at least $1,000 in tax in 2016 and you expect your withholding and credits to be less than the smaller of:
  1. 90% of the tax shown on your 2016 return, or
  2. 100%* of the tax shown on your 2015 tax return.
*Note: If your adjusted gross income for 2015 was more than $150,000 ($75,000 if you filed “Married Filing Separately”) substitute 110% in Rule #2.

When are Estimated Tax Payments due?

Here’s the four deadlines:

1st Quarter  Due April 15
2nd Quarter  Due June 15
3rd Quarter   Due Sept 15
4th Quarter   Due Jan 15 (of the following year)

Note that the IRS calendar is a bit ‘wonky’. The four ‘quarterly’ deadlines aren’t all exactly 3 months apart from each other!

Why are they called “Estimated” Taxes?

The IRS doesn’t know how much you’re going to make this year. So they leave it up to you to estimate what your taxable income will be for the year, calculate the projected tax bill on your income where there is no withholding, and then pay the tax in four quarterly payments.
If you under-estimate your income, and your tax, you could be penalized.

How to calculate “Estimated” Taxes

IRS Form 1040-ES (Estimated Tax For Individuals) is used to calculate and pay estimated tax.

To determine how much you have to pay for estimated tax, you must compile your income, deductions, credits, and paid taxes — much like filing a yearly tax return. Most people can look at their income/liability numbers from the previous year to gauge what they’ll owe the next year.

ANCHOR ON THIS: Remember that it is important to submit your tax payments on time. Even if you’ve already missed a few installments for estimated tax, you should still try to pay them as soon as possible, for two reasons: (1.) you’ll avoid IRS penalties, and (2.) more importantly, you’ll gain peace of mind knowing exactly what tax is (or is not!) due, and have a game plan in place for meeting IRS requirements. Time and again in working with taxpayers I discover that the actual requirements are less than what a client had feared. But they’d never know this had they not sat down and worked through the details at some point during the year, rather than waiting and wondering till April 15th of the following year.

If you’d like help determining what your net income is in your business, or what your taxable income will be on your rental, alimony, social security income, etc, contact me for a complimentary consultation.