The US tax system is a pay as you go system, which means you are supposed to pay taxes as you earn income. This isn’t a problem for many people because their employers withhold their taxes from their paycheck. But if you do not have enough money withheld from your paycheck or if you have additional income from self-employment, investments, real estate, or other means, you may need to pay self employment tax or make estimated tax payments.
Who Needs to Pay Estimated Taxes?
The money employers automatically withhold from your paycheck is sent in to the IRS and your state if you live in a state that assesses income tax. Ideally, the exact amount of money would be withheld and you won’t end up owing any money or receiving a tax return. However, it’s not always easy to predict your year end income or which deductions you will have throughout the year, particularly if you have unsteady income. Because of this, many entrepreneurs have to deal with self-employment and estimated taxes.
You must pay estimated tax if both of the following apply:
- You expect to owe at least $1,000 in taxes after subtracting your withholding and credits.
- You expect your withholding and credits to be less than the smaller of;
- 90% of your current year tax liability, or
- 100% of the tax shown on your previous year’s tax return.
In other words, the amount of estimated taxes you need to pay to avoid penalties is the smaller of 90% of what you will owe this year, or at least 100% of what you owed last year (110% for high income earners).
Who Does Not Have To Pay Estimated Tax
You should not have to pay estimated taxes if you will owe less than $1,000 in taxes this year, or if your employer withholds enough money through your paychecks. You can adjust your W-4 to withhold more or less money depending on your personal situation. Use the IRS Withholding Calculator to determine how many dependents you should claim, which will affect the amount of taxes withheld from your paycheck.
How To Determine How Much Estimated Tax to Pay
If you have steady income that is not subjected to automatic tax withholdings, or if you have a fairly good idea how much money you will earn in a given year, you can determine how much estimated taxes to pay with estimated tax worksheets or software. IRS Form 1040-ES includes a worksheet to calculate how much you should pay for your estimated taxes. You can also find calculators in most commercial tax software programs like TurboTax and TaxCut.
Irregular income? It can be difficult for individuals with irregular income to predict how much they will earn in a given year. Thankfully there is a safe harbor rule, which states that as long as you pay 100% of your previous year’s total tax liability in withholding and/or estimated taxes, you’ll be exempt from underpayment penalty regardless of your final tax amount (remember the 90% of current year or 100% of last year rule from above?).
A simple way to qualify for the safe harbor rule. To qualify for the Safe Harbor Tax Rule and avoid penalties, take your previous year’s tax obligation, divide by four, and make four equal payments by the estimated tax deadlines. Add 10% to last year’s tax total if you are a high income filer.
How much per installment? The IRS wants estimated taxes to be paid in equal installments, regardless of when you earn your income. This can be tricky when you don’t know how much you will earn, or if you typically have lean months in the beginning of the year, and earn more money in the latter part of the year. The easy way to avoid this is to follow the safe harbor method mentioned above. But if you want to do it a different way, then I recommend this article about calculating your estimated tax payments.
When To Pay Estimated Taxes
Estimated taxes are due four times per year on the dates listed below, or the following business day if the due date falls on a weekend or holiday. (Note the due dates are not spaced exactly 3 months apart):
- April 15th
- June 15th
- September 15th
- January 15th
How to File and Pay Your Estimated Taxes
There are two ways you can file and pay your estimated taxes: by paper or electronically.
- Pay by mail. Use IRS Form 1040-ES (download pdf here) to calculate your estimated taxes. Then fill out a voucher on the form to send along with your estimated tax payment.
- Pay Electronically. If you prefer to pay your taxes electronically, you can sign up for the Electronic Federal Tax Payment System (EFTPS) to pay your estimated taxes online. It can take up to 2 weeks to receive your PIN in the mail, so plan accordingly.
Consult a professional for more details. This information covers many (but not all) people and situations. Your specific tax situation may be different; please consult an account or IRS documentation for information specific to your needs.
Additional IRS Resources:
{ 14 comments… read them below or add one }
Really solid overview. Tax payments need to be managed– even W-2 employees need to manage it. Why give the government an interest free loans?
Super important stuff for the self employed– even Defensive Entrepreneurs running side gigs!
I would say it is important especially for defensive entrepreneurs running side gigs. Many full-time self-employed individuals take taxes into consideration year round, but many people just starting out with a side job or other entrepreneurial effort may not know about estimated taxes or may down play their importance.
It’s also nice to spread the tax burden out over the year, rather than frantically trying to pay it all at once. If you have an accountant or some other professional prepare your taxes, you an usually get pre-filled out forms to send in with your payment when your estimated taxes are due. This is very helpful as well.
Absolutely, Miranda I never know how much income my small business will bring in on a month to month basis, much less on an annual basis. So taking the tax harbor rule into mind, it is easier to take last year’s tax obligation and divide by four, then spread out the payments equally. The vouchers are easy to fill out if you are a DIY kinda person, but there is something to be said about using an accountant!
What is your opinion on this situation:
I bought a house this year with 20% down 30 year fixed loan. To take advantage of the $8000 First Time Home Buyer Credit sooner rather than later, I have had my employer withhold $0 taxes over the last couple of months. Once I hit the $8000 number I turned withholding back on.
I was just going to claim the house purchase, and receive the credit, on my 2009 taxes but I’m making more this year than I anticipated and will most likely not qualify for the full credit.
My 2008 income (~30% of my 2009 income) allows me to claim the full credit and the First Time Home Buyer Credit allows me to treat my 2009 purchase as if it happened in 2008. If I file an adjusted 2008 tax return I’m concerned that I will receive penalties because I did not withhold enough in 2009.
As long as I pay enough taxes in 2009 to cover the amount in 2008, should the Safe Harbor Rule protect me from any penalties?
M, sorry, but I’m afraid I don’t have the knowledge to answer your question. I recommend speaking with an accountant on this topic, unless another reader can chime in?
Timely post for me Patrick. Now that I am earning more and more money from my blog each month… this is a practice I need to integrate into my financial life. This post definitely helps me decide how to best proceed.
Sept 15th is the next payment deadline, so you can always get started on that date. But you will probably be OK as long as you meet the Safe Harbor requirements.
The impending deadline is why I wrote about this topic… I realized I’ve been sending in payments, but had never written about it!
Question: Based on my calculations, I’m right on the border for needing to pay estimated taxes. However, my first two payments were past the April and June deadlines. Come April of 2010, if it turns out that I never really needed to send estimated payments, would I still get penalized for sending in those 2 payments late?
Dan, if you have salaried income, then the tax withholdings from your employer are considered to have been made in equal payments regardless of when the money was actually withheld. So if you think you may be required to pay estimated taxes, you can change your W-4 to have more money withheld from your paycheck and avoid paying estimated taxes. I had additional income withheld from my day job last year for that purpose.
As for making late estimated taxes, I’m not sure. It depends if you will fall under the safe habor rules or not. If you can increase your withholdings from your day job, then you can avoid needing to make estimated tax payments.
Patrick-
As a long time estimated taxpayer, like a lot of people I was annoyed and frustrated at the payment options: vouchers and stamps or EFTPS. I always wondered why there wasn’t an easier way? So I started a service called Easy Estimated Taxes that allows people to manage and pay their estimated taxes online. Our goal is to make the entire estimated taxes process easy. I hope you’ll consider this as another payment option.
@Dan: I wouldn’t worry too much about that. So long as the government gets their money they seem to be happy. I have even missed an estimated payment and made it up later in the year. Never heard a word. I know other self-employed folks who do this regularly. Again, it is better to do them quarterly, but I think the IRS just wants to make sure they get their bounty so they don’t spend a lot of time chasing after folks who are a little late on paying.
This may change as the government needs more and more revenue, but I haven’t heard of them coming after self-employed folks. Now, if you have employees, you best be on time, especially with Social Security taxes or you will get a knock at the door.
If you are paid a salary and find yourself behind on estimated taxes, and can afford it, just have lots more taken out of salary late in the year. The way the IRS calculates penalties, it “doesnt’ care” when salary based federal tax withholding occurs so it is a nice way to catch-up if you missed 1040-es payments.
I wish there was a way to pay 1040-ES taxes without the total rip-off 2.49% charged by the tax payment companies. Why can’t the IRS accept credit cards and get rid of the highway robbery middle man?
Robert, I did something similar last year by withholding extra from my day job instead of paying estimated taxes for my small business income. It worked out well enough, but this year I planned a little better for my situation.
You can do a free electronic transfer to avoid fees, but if you insist on paying with your credit card, then you are probably out of luck in avoiding fees.