Calculating estimated taxes and paying them every quarter can be tough for a lot of people. However, filing quarterly taxes on time reduces your annual liabilities and helps you organize your finances better.
According to the Internal Revenue Service (IRS), 144.3 million taxpayers contributed about $1.5 trillion individual income taxes in the year 2018, from their reported earnings of $11.6 trillion in adjusted gross income.
This guide will help you execute an accurate calculation of your estimated taxes and provide all the information necessary to navigate the process.
What Are Estimated Tax Payments?
Estimated tax payment is the method used by self-employed or non-corporate individuals to pay their taxes four times a year. The payment is made in estimated amounts instead of a total sum.
This is because you have to estimate your expected income in a year and pay taxes accordingly. These taxes include income tax, self-employment tax, and any other tax applicable.
Estimated taxes are relevant for you if your income is not subject to automatic withholding. This income may stem from freelance earnings, interests, dividends, alimony, rentals, and so on.
Who Should Pay Estimated Taxes Quarterly?
You are eligible to pay estimated quarterly taxes if you:
- Are self-employed or a freelancer.
- Are an S corporation shareholder.
- File as a sole proprietor or in a partnership.
If you fall in these categories, you will have to pay quarterly taxes if your owed amount is $1,000 or more. Companies that file as a corporation have to pay these taxes for their annual owed amount of $500 or more.
On the other hand, you are exempt from filing quarterly taxes if:
- You are a corporate employee. In that case, your employer should withhold quarterly taxes from your income automatically.
- You didn’t owe taxes the previous year or need to file tax returns.
- You have been a US citizen for the whole year.
- Your tax bracket duration is 12 months.
In case you’re an employee, you must ensure your Form-W4 is filled out correctly and your employer has access to all your details to calculate the correct tax amount.
Why Are Quarterly Estimated Tax Payments Required?
The US tax system believes in “paying as you earn” throughout the year. Filing your quarterly taxes on time ensures the government has a recurring income. This can be done through estimated taxes or withholding amounts.
Self-employed individuals and contractors don’t have access to the withheld payment option. In this case, you are liable to make quarterly payments on your taxable income to avoid penalties.
How to Calculate Estimated Taxes
Calculating quarterly taxes is a fairly simple process. All you have to do is calculate the sum of your annual tax liability and divide it by 4. Your total tax liabilities for a year may include income tax, self-employment tax, and any other applicable tax.
This amount can also be calculated in Form 1040-ES for individuals or Form 1120-W for corporations. You can find these guides in the Estimated Tax Worksheet on the IRS website. You can also use an estimated tax calculator online.
A Step-by-Step Guide to Calculating Your Estimated Taxes
If you are still confused about how to calculate tax, we have a detailed guide for you. Let’s consider the example of Juan Lopez, who provides architectural services in San Francisco.
1. Estimate the Total Annual Taxable Income
Let’s start by calculating Juan’s annual taxable income. For that, we assume that Juan expects to make $95,000 this year, and his estimated deduction is $16,000.
Now, to calculate his adjusted gross income (AGI), you need to subtract the above-the-line deductions from the estimated income, i.e. $95,000 - $16,000 = $79,000
From this amount, Juan has to subtract the standard deduction for single taxpayers in 2021, i.e. $12,550. This brings the amount to $66,450. Now, he needs to deduct 50% of his self-employment tax from this amount.
2. Calculate Self-Employment Tax
Juan is eligible for self-employment tax as his annual income is above $400. He has to multiply his estimated annual income by 92.35% to calculate his self-employment taxable income.
Then, he should multiply this by the self-employment tax rate, i.e., 15.3%. This comes to: $95,000 x 92.35% x 15.3% = $13,423. This is Juan’s self-employment tax total.
Note that the 15.3% self-employment tax rate includes Social Security tax (12.4%) and Medicare (2.9%).
3. Calculate Income Tax
To calculate income tax, Juan multiplies his adjusted gross income by his income tax rate. This rate is subject to an annual change. Based on Juan’s tax bracket, his tax rate is 22% and his estimated income taxes owed for the year is $10,367.50.
His estimated taxes will now total to: $10,367.50 (estimated owed tax) + $13,423 (estimated self-employment tax) = $23,790,50
4. Calculate Quarterly Estimated Tax Payment
To get the final quarterly figure for each quarter, Juan divides the total estimated tax figure by 4, which gives $5,947.63. This should be Juan’s quarterly tax payment amount.
You can take the help of a CPA or a quarterly tax calculator for your payments to determine the accurate amount of estimated payments.
What Are the Due Dates for Filing Estimated Taxes?
Once you have figured out how to pay quarterly taxes, you must ensure that the due dates are not missed. There are four due dates over the year for your tax payment. They are:
- For the first quarter (January to March): April 15
- For the second quarter (April to May): June 15
- For the third quarter (June to August): September 15
- For the fourth quarter (September to December): January 15 of the next year
The date shifts to the next working day in case these dates are holidays.
How to Pay Estimated Taxes
It is easy to learn how to file quarterly taxes. You can choose these options.
- Fill out Form 1040-ES and mail it with the payment check to your nearest IRS office.
- Pay online or through your phone via the IRS Payments Gateway.
- Corporations can pay through the Electronic Federal Tax Payment System.
Will I Be Liable to Tax Penalties?
Yes, not paying your taxes on time might result in penalties. The IRS can impose quarterly tax payment penalties if you end up missing the deadline or pay less than the estimated tax amount.
You can avoid the underpayment or overpayment penalty by paying:
- At least 90% of the yearly tax bill, or
- The same amount as the taxes owed last year, whichever amount is smaller
You can also use an estimated tax penalty calculator online to get an idea of the penalties owed.
The “Safe Harbor” Rule
When it comes to paying taxes, it's best to be safe than sorry. The “safe harbor” rule refers to paying the entire amount of taxes you owed in the previous year.
If in case your income exceeds that of the previous year, you won’t be charged a penalty if you pay 100% of what you owed last year. You merely have to file the additional amount later.
But if your annual income is above $150,000, you must pay 110% of your previous year’s taxes to avoid penalties. Plus, these rules apply to federal taxes. You might need to pay quarterly state taxes if your state charges income tax.
What If Freelancing Is My Side Hustle?
With the rising gig economy, many people choose to freelance along with working full-time. Unfortunately, this may lead to confusion while filing taxes as you don’t get tax returns.
In this case, you can opt for additional withholdings from your employer to be exempt from quarterly taxes. This can also be availed if your spouse has a regular job and you file taxes jointly.
Revising your withholding amount lets you owe less than $1,000 and avoid penalization for underpayment. Here's how you go about it:
- Fill out a new W-4 form.
- Under “Other Income” on the form, enter your expected net income from freelance work.
- Alternatively, you can use the IRS Tax Withholding Estimator to calculate your withholding amount accurately.
How to Keep Track of Payments
It is essential to keep track of your tax payments for further tax filing. Make sure to record the date and amount of your payments. However, in case you forget to do so, you can request a transcript from the IRS on their website.
Conclusion
Tax payments don’t have to be stressful nowadays, as you can pay estimated taxes online through the IRS portal. Not only that, you get multiple tools to automate the calculation of your estimated tax after entering your income and deductibles.
The thing to remember is that quarterly taxes are simply an estimation of your income. It doesn’t have to be exactly accurate as your income may change throughout the year. If you file this on the basis of your previous records, you will be good to go.
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