Taxpayers often wonder if they should be making estimated tax payments throughout the year, or pay taxes when they are due April 15. Generally, the answer is “it depends.” Typically, individuals who are self-employed or sole proprietors pay their federal (and sometimes state) income tax by making estimated tax payments. These are quarterly payments that are estimated by the IRS based on your previous year’s income and tax filing. However, self-employed individuals are not the only ones that may need to pay estimated taxes. Here’s an overview of who may need to pay estimated taxes to ensure they are meeting their tax obligations.
Whether you are self-employed or have a job where the company withholds and remits taxes on your behalf, everyone must pay the IRS federal income tax. Taxpayers who receive income from sources not subject to withholding, or do not have enough withheld, may have to make estimated tax payments. Generally, individuals, including sole proprietors, partners, and S corporation shareholders, must make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed. Estimated tax is used to pay not only income tax but other taxes such as self-employment tax and alternative minimum tax.
However, there are taxpayers who receive income from sources other than employment, which may benefit from paying estimated taxes. These may include individuals with significant investment income (interest, dividends, capital gains), those that earn rental income, and have substantial income from retirement accounts. Other scenarios include taxpayers who receive alimony or other taxable income without withholding, or sell property or other assets for a taxable gain.
If a taxpayer is unsure whether they should be paying estimated taxes, consider the “90% or 100% of last year’s tax” rule. This means that taxpayers can avoid an estimated-tax penalty if they pay at least 90% of their current-year tax liability, or 100% of the prior year’s tax liability. If you are a taxpayer who pays taxes through an employer, then you may already be paying enough through your paycheck. If you owe money at the end of the tax year and do not want to make estimated tax payments, you can increase your federal withholding on the W-4 rather than making separate quarterly estimated payments.
Estimated taxes are paid quarterly during the following months: April, June, September, and January of the following year. Most taxpayers who make estimated tax payments pay on a quarterly basis. However, they can also be made weekly, bi-weekly, monthly, etc. if they have paid enough in by the end of the quarter. If you do make estimated tax payments, make sure to pay by the deadlines or you could face an underpayment penalty. This happens when insufficient tax was paid throughout the year.
There are several ways to make estimated tax payments. The IRS suggests taxpayers pay online, use Form 1040-ES and pay by mail, or by phone. Additionally, individuals can pay through their IRS Individual Online Account, where they can also see their payment history and other tax records.
Remember that you do not have to be self-employed to owe estimated taxes. If you have income that isn’t subject to sufficient withholding, the IRS may expect you to make payments during the year, even if you receive a regular paycheck. Additionally, you always want to check your state tax rules to see if you should be making estimated tax payments there as well. If you are unsure, working with an experienced tax professional can help assure you are making payments correctly and often enough to avoid penalties and more taxes down the line.
Allison Soares is a partner and tax attorney at Vanst Law LLP. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits from San Francisco to San Diego.
