If you’re a W2 employee and have adequate taxes withheld from your paycheck, then you’ve likely never had to think about making estimated tax payments. But for those with a source of untaxed income, estimated payments are essential if you want to avoid penalties and fees from the IRS. The US tax system is pay-as-you-earn system, which means the IRS expects to receive your taxes as you receive income—not just one lump sum when you file in April.
So, if you have a source of untaxed income, here’s a basic overview of what you need to know about making estimated tax payments.
Who Pays Estimated Taxes?
As we mentioned, estimated tax payments apply to anyone with an income source that is not taxed upfront. This may include:
- Partners and sole proprietors in a business
- Shareholders in an S-corp
- Freelancers and contractors
- Individuals who receive income from stock dividends
There are other types of untaxed income as well, so when in doubt, be sure to speak to a professional tax planner in Provo for assistance in determining whether or not you should be making estimated payments.
When Should You Make Your Estimated Payments?
If you’re new to the untaxed-income world, you might think that it’s okay to just pay any taxes you owe once you file your tax return. But this is not the case. If you receive untaxed income throughout the year, you should be making estimated payments four times a year. These are often called quarterly payments; however, the dates don’t align with traditional calendar quarters. The payment deadlines and their associated earning periods are as follows:
- For income earned January 1 through March 31: April 15
- For income earned April 1 through May 31: June 15
- For income earned June 1 through Aug 31: September 15
- For income earned September 1 through December 31: January 15
You should make an estimated tax payment on or before the deadline dates above, based on the amount you earned in the corresponding date range. However, if you receive most of your untaxed income in a single quarter (e.g., stock dividends that are paid out at the end of the year), you can make your estimated tax payment when that income is received.
How Much Should You Pay?
Obviously, there is no one-size-fits-all answer to this question, and calculating the best amount to pay each quarter can be a challenge. This is especially true for those who have an inconsistent source of untaxed income, such as with business owners whose profits fluctuate throughout the year. These fluctuations can cause you to be in a higher tax bracket in one quarter than others, and make calculating your estimated payments difficult.
The IRS’s recommendation is to first calculate your total estimated tax for the year, and then divide that number by four to determine how much to pay in each quarter. The best way to do this is to provide your estimated income amounts to your accountant at Biesinger & Kofford CPAs, and we will help you calculate how much you should pay.
However, if you believe your income will be similar from year to year, another option is to look at last year’s 1040 to see the “total tax” entry. Take this number, and deduct any withholdings you expect to have this year. This will give you the total estimated tax you owe this year. Divide that number by four to calculate your quarterly payments. Keep in mind though that the new tax law put into effect for 2018 may influence the accuracy of this method.
Of course, it’s unlikely that your earnings (and therefore, the amount you owe) are going to be exactly the same every year. But the method outlined above works fairly well due to the IRS’s “safe harbor” policy. This policy states that as long as you have paid at least 90% of the taxes you owe, or have made a “safe harbor” payment (calculated based on a percentage of the taxes you owed last year), then you are compliant with paying your taxes. This will protect you from fees and penalties for underpayment, as long as you have been making reasonable estimated payments.
So, if you receive any untaxed income throughout the year, be sure to make regular estimated tax payments. If you don’t, and you end up owing over $1,000 when you file your return (or more than $500 for a corporation), you could be facing additional fees and penalties for underpayment. If you need assistance calculating your estimated payments so that you can avoid these fees, contact us at Biesinger & Kofford CPAs to speak to a professional tax planner in Provo and get the help that you need.