Taxes are supposed to be paid as you earn or receive income during the year, either through withholding or estimated tax payments. If the amount of income tax withheld from your salary or pension is not enough, or if you receive income such as interest, dividends, alimony, self-employment income, capital gains, prizes or awards, you may be required to make estimated tax payments. These payments are made quarterly.
If you are in business for yourself, you generally need to make estimated tax payments. Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and alternative minimum tax.
If you don’t pay enough tax through withholding and estimated tax payments, you could be charged a penalty. You also could be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.
Who is Required to Pay Estimated Tax
Individuals, including sole proprietors, partners, and S corporation shareholders, generally are required to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.
Corporations generally are required to make estimated tax payments if they expect to owe tax of $500 or more when their return is filed.
You may be required to pay estimated tax for the current year if your tax was more than zero in the prior year.
Who is Not Required to Pay Estimated Tax
If you receive salaries and wages, you can avoid having to pay estimated tax by asking your employer to withhold more tax from your earnings. To do this, file a new Form W-4 (PDF) with your employer. There is a special line on Form W-4 for you to enter the additional amount you want your employer to withhold.
You don’t have to pay estimated tax for the current year if you meet all three of the following conditions.
You had no tax liability for the prior year 1
You were a U.S. citizen or resident for the whole year
Your prior tax year covered a 12-month period
How to Figure Estimated Tax
Individuals, including sole proprietors, partners and S corporation shareholders generally use Form 1040-ES (PDF), to calculate estimated tax. To do this, you must figure your expected adjusted gross income, taxable income, taxes, deductions and credits for the year.
Alternatively, you could ask your tax professional to assist you with a tax plan for the current year, which is advised if you have or plan any substantial changes or significant items taking place during the year.
When figuring your estimated tax for the current year, it may be helpful to use your income, deductions and credits for the prior year as a starting point. Use your prior year's federal tax return as a guide. However, keep in mind you need to estimate the amount of income you expect to earn for the current year. You want to estimate your income as accurately as you can to avoid penalties.
Corporations generally use Form 1120-W (PDF), to figure estimated tax.
When to Pay Estimated Taxes
For the purpose of estimated tax, the year is divided into 4 payment periods. Each period has a specific payment deadline, and failing to pay on time can result in IRS penalties:
January 1 — March 31: Deadline is April 15
April 1 — May 31: Deadline is June 15
June 1 — August 31: Deadline is September 15
September 1 — December 31: Deadline is January 15 (of the following year)
Using the Electronic Federal Tax Payment System (EFTPS) is the IRS' preferred method for individuals as well as businesses to pay federal taxes. However, these taxes can also be paid by check or by online payment through the IRS web site. If you do sign up for EFTPS, you must make ALL of your federal tax payments including federal tax deposits (FTDs), installment agreement and estimated tax payments using EFTPS. If it’s easier to pay your estimated taxes weekly, bi-weekly, monthly, etc. you can, as long as you’ve paid enough in by the end of the quarter. Using EFTPS, you can access a history of your payments, so you know how much and when you made your estimated tax payments.
Penalty for Underpayment of Estimated Tax
If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. Please refer to Publication 505, Tax Withholding and Estimated Tax, for additional information.
However, if your income is received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income and making unequal payments. Use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates, and Trusts (or Form 2220, Underpayment of Estimated Tax by Corporations), to see if you owe a penalty for underpaying your estimated tax.
The penalty may also be waived if:
The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.
You retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required to be made or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.
William D. Truax, E.A. and his friendly team of licensed tax preparers have been helping individuals and businesses with estimated payments for over 30 years. He is licensed to represent taxpayers before the IRS and is also a member of the Bar of the United States Tax Court.
If you need assistance or have questions about your estimated tax payments, please contact us today for a FREE consultation. We’re here to help!
1 You had no tax liability for the prior year if your total tax was zero or you didn’t have to file an income tax return. For additional information on how to figure your estimated tax, refer to Publication 505, Tax Withholding and Estimated Tax.