Determining Your Estimated Tax Payments

How can I figure out if I must pay estimated taxes, and, if so, how much will I owe?

If you're an employee, your boss takes money out of every paycheck, and sends that to the IRS (and maybe your state government, too) to pay part of your income taxes. Through withholding, you pay your income taxes as you go.

But if you are self employed, or if you have income beyond what you are paid as a salary, you need to estimate the part of your income for which you have not paid taxes through withholding, and every quarter, you must pay taxes on that estimated income.

You may owe estimated taxes if you earn income that isn't subject to withholding, such as:

• Interest income
• Dividends
• Gains from stock sales
• Earnings from a business in which you are the sole proprietor
• Alimony

Do I Need to Pay Estimated Taxes?

That depends on your situation. The rule is that you must pay your taxes as you go. If, when you file your return, you have not paid enough income taxes through withholding or quarterly estimated payments, you may have to pay a penalty for underpayment.

To determine whether you need to make those payments, answer these questions:

1. Do you expect to owe less than $1,000 in taxes for 2005 after applying your federal income tax withholding to the total amount of taxes that you expect to owe? If so, you're safe -- you don't need to make estimated tax payments.
2. Do you expect your federal income tax withholding (or estimated taxes paid on time) to amount to at least 90% of the tax that you will owe on your 2005 return? If so, then you're in the clear and you don't need to make estimated tax payments.
3. Do you expect that your income tax withholding will be at least 100 percent of the tax that you paid on your 2004 return? Or, if your adjusted gross income (Form 1040, line 36) on your 2004 tax return was over $150,000 ($75,000 if you're married and file separately in 2005), do you expect that your income tax withholding will be at least 110% of the tax you owed on your 2004 return? If so, then you're not required to make estimated tax payments.

If you answered no to all of these questions, you must make estimated tax payments with Form 1040-ES. You must make total tax payments (estimated taxes plus withholding) during 2005 so you meet one of these requirements:

1. You make enough payments to add up to at least 90 percent of what you owe in 2005, or
2. You make enough payments to add up to 100 percent [or 110 percent if your 2004 income was more than $150,000, ($75,000 if married and filing separately in 2005)] of the tax you paid in 2004

Which Option Should I Choose?

That depends on your situation.

The safest option to avoid an underpayment penalty for 2005 is to choose "100 percent of your 2004 taxes." If your 2004 adjusted gross income was more than $150,000 (or $75,000 for those who are married and filing separate returns in 2005), you should pay 110% of your 2004 taxes.

If you expect your 2005 income to decrease and you don't want to pay more taxes than you will end up owing at the end of 2005, you can choose to pay either 90 percent or 100 percent of your estimated 2005 tax bill. If your estimated payments add up to less than 90 percent of what you owe you may face an underpayment penalty. So if you choose the 100 percent option, you'll have a little safety net.

If you expect your 2005 income to increase and you don't want to end up owing any taxes when you file your 2005 return, choose the option to pay 100 percent of your 2005 income tax liability through estimated payments.

How Should I Figure What I Owe?

You need to come up with a good estimate of the income and deductions you will report on your federal tax return next year.

TurboTax is the smartest way to figure your estimates. TurboTax helps you determine the amount of quarterly estimates you should pay and allows you to print the tax forms you'll need.

Or get a copy of the worksheet accompanying Form 1040-ES and work your way through it.

Either way, you'll need some items so you can plan what your estimated payments should be:

• Your 2004 return. Use your 2004 federal tax return as a check to make sure you include all the income and deductions you expect to take on your 2005 tax return. You also look at the total tax you paid, if you are going to make payments that amount to 100 percent of that year's taxes.
• Your record of any estimated tax payments you've already made for 2005. You need to take those payments into account when you determine how much tax you still owe, so have your check register handy so you can look up the amounts and dates you paid.

Tip

One way to get a jump on paying your 2005 taxes is to apply your 2004 tax refund to your 2005 taxes instead of getting a refund. If you won't have federal income tax withheld from wages or if you have other income and your withholding will not be enough to cover your tax bill, you probably need to make quarterly estimated tax payments. Having all or part of your overpayment applied to your estimated taxes is a relatively painless way to take care of some of what you owe for 2005.

What If I Do Not Pay?

If you're required to make estimated tax payments, and you don't, you could end up owing the IRS an underpayment or estimated tax penalty in addition to the taxes that you owe.

Result: you have to write a larger check to the IRS when you file your return.

Should I Pay in Equal Amounts?

Usually, you pay your estimated tax payments in four equal installments. But you might end up with unequal payments in some circumstances:

• If you have your 2004 overpayment credited to your 2005 estimated tax payments
• If you don't figure your estimated payments until after April when the first one is due, you might end up with unequal payments
• If you unexpectedly make a lot of money one quarter

Example

You calculate that you need to pay $10,000 in estimated taxes throughout the year, and you don't make your first payment until June 15 (when the second estimate is due), so your first payment will be $5,000. Your September payment and your January 2006 payment will be $2,500 each.

If You Are a Farmer or Fisherman

You have special criteria to meet, but you may end up paying less in estimated taxes. You're considered a qualified farmer or fisherman if you earn more than two thirds of your gross income from farming or commercial fishing. If you're not sure you qualify, or how this all works, get IRS Publication 595: Tax Highlights for Commercial Fisherman, or IRS Publication 225: Farmer's Tax Guide. These publications tell you how to figure your gross taxable income and what fishing and farming income you can include as qualified income.

For More Information

See FAQs on Estimated Taxes.