Depending on your type of employment, level of income, and the previous tax year, you may be required to make estimated payments. Estimated payments are essentially a series of pre-payments made toward an individual or corporation’s tax liability for the current tax year. Usually paid on a quarterly basis, estimated payments help taxpayers avoid unnecessary penalties and prevent an unexpectedly high tax bill come tax season.
Who is required to make estimated payments?
Estimated payments are generally required of individuals and corporations who meet certain criteria.
Individuals who expect to owe $1,000 or more with their next tax return are required to make estimated payments. This includes:
Members of partnerships
Shareholders of S corporations
Landlords who earn rental income
Employees who had too little tax withheld from their paychecks during the previous tax year
Note an important exception to this requirement: U.S. citizens or resident aliens who owed no tax for the previous year are not required to pay estimated taxes for the current year, even if they expect to make significantly more money. However, it may be a good idea for these individuals to make estimated payments anyway in order to avoid having to pay a large lump sum at tax season.
Because self-employed individuals are not subject to automatic tax withholding, business owners and freelancers are usually required to make estimated payments. However, if a business owner also works for an employer and receives paychecks subject to withholding, he or she may opt to increase their withholding amount to account for the entire year’s tax liability. By taking this route, the business owner may be able to avoid making estimated payments for their business.
Employees whose paychecks are subject to withholding may choose to adjust their withholding amount in order to avoid having to make estimated payments. The IRS’s Paycheck Checkup tool will help you to determine your ideal withholding amount.
Corporations are required to make quarterly estimated payments if they expect to owe at least $500 with their next tax return.
I am required to make estimated payments. What will happen if I don’t?
Estimated payments are due quarterly (every 3 months). The first payment is due April 15th, with subsequent payments due June 15th, September 15th, and January 15th. If you owe estimated tax but fail to make an estimated payment by its quarterly deadline, the IRS will charge interest on the unpaid tax. This interest compounds daily and is added to the unpaid tax from the date it was due until it is paid.
In order to avoid these penalties, your estimated payments must equal at least 90% of your actual tax liability, or either 100% or 110% of your tax liability from the previous year (depending on your income level). To play it safe, it’s a good idea to “penalty-proof” your estimated payments by paying 110% of the previous year’s tax liability. For example, if you owed $10,000 the previous year, with $2,000 coming from withholding and $8,000 in the form of estimated payments, the following year you would pay $11,000 total in order to avoid any penalties ($2,000 from withholding and $9,000 in estimated payments). Even if you end up making far more money than the previous year, the IRS will not assess any additional interest charges to your tax bill.
Have more questions? Contact your local CPA firm today.