Between 2010 and 2015, the number of people who face tax penalties for not making estimated tax payments jumped by 40%. Arguably, this increase is due to the rise in the gig economy as well as to challenges faced by small business owners.
If you have self-employment income, own a business, have rental properties, earn capital gains, or fall into multiple other categories, you need to make quarterly income tax payments. The Internal Revenue Service (IRS) charges taxpayers 6% in interest on unpaid estimated tax payments, and to avoid these tax penalties, you need to make your payments.
Who Needs to Make Estimated Tax Payments?
You do not have to pay a penalty for missing estimated tax payments if you fall into one of the following categories:
- You paid at least 90% of the tax owed for the current year.
- You paid at least 100% of the tax you owed the previous year.
- You owe less than $1000 for the current year.
As a result, you usually do not have to make estimated tax penalties the first year you have freelance or business income. In other words, if you didn't owe any income tax the previous year, you don't have to make quarterly payments during the current year. However, you may want to make payments to avoid a big bill when you file your tax return.
How Do You Calculate Your Quarterly Estimated Tax Payments?
To stay in line with the numbers above, you can base your estimated tax payments on the amount you owed last year. For example, if you owed $2,000 in tax last year, you can make four quarterly payments of $500 each, and that satisfies your requirement for paying at least 100% of the amount you owed the previous year.
However, if your current tax liability is less than less year, you only have to pay 90% of the taxes owed for the current year. To give you an example, imagine that you owed $4,000 in income tax last year but you are only going to owe $3,000 this year.
In this situation, you can avoid the tax penalties not making estimated tax payments by paying $2,7000 throughout the year. Although that is less than the $4,000 you owed the previous year, it's 90% of the amount owed for the current year.
Again, if you owe less than $1,000 in tax for the year, you don't have to make estimated tax payments. So, you don't have to worry about these penalties.
How to Avoid Estimated Tax Penalties
If you want to avoid incurring an estimated tax penalty, you need to make quarterly payments. For easy accounting, you can simply divide the tax owed on the previous year by four and remit those amounts every quarter. If you anticipate earning less and you don't want to make such large payments, you can use Form 1040-ES to estimate your payments based on your anticipated taxable income, taxes, deductions, and credits.
This form also helps you calculate the right amount to pay if your income fluctuates a lot from quarter to quarter. These calculations can be complex so you may want to consult with an accountant to ensure that you pay the right amounts and avoid as many tax penalties as possible.
Additionally, if you have an employer, you may want to increase the amount of taxes withheld from your paycheck. These withholdings can help to cover taxes due from other income sources where the payer doesn't withhold anything, such as income you earn as a freelancer, sole proprietor, member of a partnership, S-corp owner, investor, landlord, and more. You need to give your employer a new W-4 form so that they can change your withholding.
When to Make Quarterly Tax Payments
Your estimated quarterly tax payments are due four times per year on the following dates for the previous quarter:
- April 15
- July 15
- October 15
- January 15
If these dates fall on a weekend or holiday, the payment is due the following business day. You need to submit your payment or post mark it by these dates. You can mail estimated tax payments to the IRS, make payments electronically or over the phone, or even pay at participating 711 stores.
Running a business is hard work, and you don't want to pay out more than you should in taxes. To keep your tax liability low, to avoid penalties, and to make sure you make all your estimated tax payments on time, consider hiring a professional accountant in Charlotte, North Carolina.
To learn more, contact Scott Boyar, CPA. We provide full-time, year-round bookkeeping, QuickBooks, and tax services to businesses and individuals in the area.