FAQs on Estimated Taxes

If you're self-employed or earning significant amounts from investments or other sources, you may have to pay estimated taxes. Are you covered?

Income taxes must be paid as you earn money. And if you are self-employed or make a lot of money on your investments, you may need to make estimated tax payments every quarter, rather than wait until you file your annual tax return. Here's how estimated taxes work.

• What are estimated taxes?
• How do I calculate my estimated taxes?
• What if my income has jumped?
• How should I track what I've paid?
• What forms do I need?
• When are my estimated taxes due?
• When can I avoid paying estimated taxes?
• Are there any reasons to pay the penalties?

What Are Estimated Taxes?

If you are self-employed, or make substantial gains on your investments, you may need to pay estimated taxes. This is because the IRS wants its money every quarter, rather than waiting for you to file your annual returns. You must estimate how much income you have each quarter, and pay taxes on that amount.

If you ever worked as an employee, you know the net earnings on your paycheck are much less than the gross earnings. Your employer withheld money from your paycheck to pay for social security, Medicare, and income taxes. If your income is earned by wages, you generally do not have to worry about paying estimated taxes. Instead, you simply need to make sure your employer withholds enough. However, if you earn significant money but taxes are under-withheld from your checks, you probably need to pay estimated taxes.

If you're self-employed, you must estimate social security, Medicare taxes, and income taxes every quarter. When you send your check for estimated taxes, you are prepaying your income tax and self-employment taxes. If you postpone payment until your income tax return is due, the IRS will charge penalties and interest.

If you do not pay enough in estimated taxes, you could face a penalty even if your return shows you deserve a refund.

How Do I Calculate My Estimated Taxes?

In most cases, you must make estimated tax payments if you expect to owe $1,000 or more in taxes for the year.

• If your prior year adjusted gross income was less than $150,000, then you can pay either 90 percent of this year's income tax liability or 100 percent of your income tax liability from last year (dividing what you paid last year into four quarterly payments).
• If your prior year adjusted gross income was greater than $150,000, then you must pay either 90 percent of this year's income tax liability or 110 percent of last year's income tax liability.

Note: If you are a farmer or a fisherman, replace the 90 percent shown above with 66.67 percent. Because many special rules apply to farmers, refer to IRS Publication 225: Farmer's Tax Guide for additional information.

What if My Income Has Jumped?

Most people pay just over 100 percent of their prior-year income tax liability as long as their business income doesn't change dramatically. But even if you pay 100 percent (or 110 percent as the case may be) of your prior year income tax, you may discover that you still owe more money to the IRS when you prepare your income tax return.

In fact, if your business income has increased substantially, you might owe a considerable amount of additional income tax, another aspect of success.

To avoid having to write large checks to both the IRS and your state when your income tax return is due, you may want to pay additional estimated taxes ahead of time. If you do, you're sending the IRS funds that they will eventually receive. But you're also reducing your working capital. So, you lose the chance to invest these monies until your income tax return is due.

How Should I Track What I've Paid?

An important note: After you start paying estimated taxes, be sure to keep a separate record of the dates you paid them and how much you sent for each period. This is where many people don't keep accurate records, which results in increased income tax return preparation time and possibly not receiving proper credit for the tax you paid. If you pay estimated taxes, be sure to get credit for them when you file your income tax return.

What Forms Do I Need?

For estimated taxes, use Form 1040-ES: Estimated Tax for Individuals. This form includes a worksheet to help you determine your estimated tax.

When Are My Estimated Taxes Due?

While estimated taxes are used to prepay your future income tax liability, each quarterly payment is generally based on your income during the quarter. There may also be instances where you make your payments based on expected future income or when you make a minimum payment because you earned so little during that quarter.

Example: If you operate a business that depends on sunny weather and you experience a particularly rainy first quarter, you can pay just the minimum required to keep you from incurring a penalty. If, on the other hand, your business results are up substantially in the third and fourth quarters, you may want to recalculate what you think you'll owe and pay additional estimated taxes to ease the future expected income tax bill.

The periods and due dates are as follows:

Note: If an estimate would be due on a holiday, Saturday, or Sunday, it is due on the next business day.

Also note: If at least two-thirds of your gross income is from farming or fishing, you have only one estimated tax payment for the year, which is due by January 15 of the following year.

When Can I Avoid Paying Estimated Taxes?

If you expect to owe less than $1,000 in income tax this year, you don't have to make estimated tax payments.

If all your income comes in salary and your employer is withholding taxes for you, unless you inherit a mansion or win the lottery, you should not need to pay any estimated taxes.

If you start a side business (and you report your income from that business on Schedule C) while continuing to work for an employer who withholds from your paycheck, you may be able to adjust your withholding so that it equals what your tax liability would be for the entire year. In that case, you will not need to pay estimated taxes on your side business.

Are There Any Reasons to Pay the Penalties?

Some people prefer to pay the underpayment penalty for not sending in their estimated taxes. For these people, it is worth paying the penalty to avoid the hassle of tracking the payment due dates and tracking the amount of payments they've made.

TurboTax guides you through estimated taxes.

For More Information

If you have further questions about estimated taxes, you can always refer to IRS Publication 505: Tax Withholding and Estimated Tax.