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Paying Estimated Taxes: What You Need to Know

Stephen Fishman
Tax expert and contributor MileIQ

The United States has a "pay as you go" tax system in which estimated tax payments are made to the IRS throughout the year. Paying quarterly tax payments often trip up self-employed workers.

Let's go over what you need to know for paying estimated taxes.

How to pay estimated taxes

Employees have their income, Social Security and Medicare taxes withheld by their employers and paid the IRS quarterly or monthly. Withholding also includes business owners who have formed corporations to own and operate their businesses.

Yet, most small business owners are not incorporated. Instead, they are sole proprietors, partners in partnerships or members of limited liability companies.  These business owners are self-employed for tax purposes.

When you're self-employed, no taxes will be withheld from your compensation by your clients and customers, or by your business itself. You have to pay your income and Social Security and Medicare taxes yourself. Typically, individuals make four annual estimated tax payments to the IRS each year.

You must pay estimated taxes if you expect to owe at least $1,000 in federal tax for the year. Yet, if you paid no taxes last year, you don't have to pay any estimated tax this year no matter what your tax tally for the year. But this is true only if you were a U.S. citizen or resident for the year and your tax return for the previous year covered the whole 12 months.

You also don't have to pay estimated tax if you have a W2 job and the amount withheld from your pay will amount to at least 90 percent of the total tax you'll have to pay.

When to pay estimated taxes

You must ordinarily pay your estimated taxes in four installments, with the first one due around April 15:

          Date      What's Due      Payment Period        April 15  Pay first installment of estimated tax  Jan. 1 - March 31    June 15Pay second installment of estimated tax April 1 - May 31  Sept. 15Pay third installment of estimated tax June 1 - Aug. 31    Jan. 15Pay final installment of your previous year estimated taxes Sept. 1 - Dec. 31        

You don't have to start making payments for any given year until you actually earn income. If you don't receive any income by March 31, you can skip the April payment.

In this event, you'd ordinarily make three payments for the year, starting on June 15. If you don't receive any income by May 31, you can skip the June 15 payment as well and so on.

Don't get confused by the fact that the January 15 payment is the fourth estimated tax payment for the previous year. The April 15 payment is the first payment for the current year.

You can also skip the January 15 payment if you file your tax return and pay all taxes due for the previous year by January 31 of the current year. This is a little reward the IRS gives you for filing your tax return early.

Yet, it's rarely advantageous to file early because you'll have to pay any tax due on January 15 instead of waiting until April 15 or 18. In other words, you'll lose three months of interest on your hard-earned money.

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How much do you have to pay for estimated taxes?

Ideally, the four estimated tax payments you make each year will add up to your tax liability for the year. Although, it is sometimes hard to estimate how much you must pay during the year. The IRS will impose a penalty if you don't pay enough estimated tax.

There is a way to avoid having to estimate how much you'll make this year. No matter what your income for the current year turns out to be, you won't have to pay any penalties if the estimated tax you pay is at least the smaller of:

  • 90 percent of your total tax due for the current year
  • 100 percent of the tax you paid the previous year or 110 percent if you're a high-income taxpayer

Many self-employed people establish separate bank accounts to save up for taxes. The amount you deposit will depend on your federal and state income tax brackets and your tax deductions.

Depending on your income, you'll probably need to deposit 15 percent to 50 percent of your pay in the highest tax brackets. If you set aside too much, of course, you can always spend the money later on other things.

How to pay estimated taxes

Paying estimated tax is easy: you can do it by check, electronic funds withdrawal or even by credit card. You should use IRS Form 1040-ES, Estimated Tax for Individuals, to pay your estimated tax. The form includes detailed payment instructions.

What if you've paid too little?

The IRS imposes a monetary penalty if you underpay your estimated taxes. The penalty is not very onerous. You have to pay the taxes due plus a percentage penalty for each day your estimated tax payments were unpaid.

The percentage is set by the IRS each year. Currently, it's about 3 percent. This is the mildest of all IRS interest penalties.

Many self-employed people decide to pay the penalty rather than take money out of their businesses during the year. If you do this, though, make sure you pay all the taxes you owe for the year by April 15 of the following year.

If you don't, the IRS will tack on additional interest and penalties. The IRS usually adds a penalty of .5 percent to 1 percent per month to a tax bill that's not paid when due.

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