Dealing with the IRS isn’t always simple and straightforward. Most employed individuals have the luxury of paying regular income tax which is withheld from their paychecks. But depending on what kind of work you do and how you do it, you may be obliged to pay quarterly estimated taxes.
What Are Quarterly Estimated Taxes?
The IRS requires you to pay tax on the money you earn as you earn it. W-2 income earners normally have the necessary amount taken from their paycheck on their behalf. However, those that are self-employed or earn income as an independent contractor have to make quarterly estimated tax payments on a quarterly basis (aka 4 times a year). It’s important to point out that even if you are a W-2 employee, you may still need to make quarterly estimated tax payments because your withholding is too low.
Here are the rules the IRS has laid out regarding which individuals need to make quarterly estimated tax payments. First, you need to pay if you owe at least $1,000 in federal income taxes for the tax year, after accounting for withholding and refundable credits.
You also need to pay if your withholding and refundable credits cover the lessor of:
- Less than 90% of your tax liability for the current tax year, or
- Less than 100%/110% of your prior year tax liability
Well, which is it 100% or 110%? If your adjusted gross income was more than $150,000 as a joint folder ($75,000 if single), you will need to use 110% of your prior year tax liability.
Self-Employed Earners
Knowing all this, it’s no surprise that self-employed individuals are more often subjected to estimated quarterly taxes than W-2 employees. Freelancers, independent contractors, and even people with side gigs are often required to pay.
The main reason self-employed earners often end up paying quarterly estimated taxes is straightforward. You simply don’t work under an infrastructure where taxes are automatically withheld from your income.
Investors
Many investors, including landlords, are required to pay quarterly taxes as well. People earning rental income, dividends, capital gains, and other investment income might need to pay quarterly taxes. The reason for this is similar to the reason for the self-employed – a lack of automatic withholding on additional income.
When Do You Pay Quarterly Estimated Taxes?
If you need to pay quarterly estimated taxes, you need to pay by the four general set dates (these dates may change by a day or two depending on if the dates below fall on a weekend):
- April 15th
- June 15th
- September 15th
- January 15th
The periods during which you accrue your quarterly tax bills are, respectively, as follows:
- January 1st to March 31st
- April 1st to May 31st
- June 1st to August 31st
- September 1st to December 31st
These dates are set by the IRS and don’t correspond with each quarter of the calendar year. That means you need to plan ahead to meet the payment deadlines on time.
One way to plan ahead is to set money aside each month. It’s easier to spread your payments over 12 months than it is to just pay quarterly.
How Much Do I Need To Pay?
There are a few ways you can approach calculating your quarterly taxes.
Self-employed individuals, sole proprietors, and S-Corp shareholders normally use Form 1040-ES to make payments of their quarterly taxes. The Form 1040-ES includes calculating instructions and worksheets. Also, the IRS provides tools on their website to calculate your estimated tax due. The IRS does not see these calculations when you send in your payment with Form 1040-ES.
When you’re filling out Form 1040-ES, you should refer to your income and your necessary or eligible deductions and credits. Normally, your previous tax year will serve as a trustworthy guide. However, it’s your responsibility to estimate the income you expect to earn during the year.
Also, most tax preparation software include the calculation of estimated tax payments for the next year based on the 100%/110% prior year tax liability.
Outsource Your Calculations
You can do these tasks on your own. But if you don’t have the time or just want to be rest assured it’s all done properly, you can hire a tax professional to help you.
How Do I Pay?
Regardless of how you calculate your quarterly taxes, you’ll pay them the same way.
You can mail your quarterly tax payments alongside IRS Form 1040-ES. Or you can pay electronically by using the IRS Direct Pay or the Treasury’s Electronic Federal Tax Payment System.
If you choose to use the IRS Direct Pay system, you can pay quarterly taxes with ACH direct bank debit or a credit card, but you will have to pay a processing fee of around 2% if you choose to use a credit card. Most states also offer the option to pay electronically. At Cerebral, we HIGHLY recommend making your payments electronically because it is less likely to get lost in the mail or entered into the wrong year by human hands.
Lastly, some IRS retail partners accept cash payments. However, you’ll need to refer to those partners to find out about any extra fees for cash payments through the IRS.gov website.
What If I Miss The Deadline? Can’t I Just Pay Up Later?
You technically do not have to make estimated tax payments. However, if you fail to make the necessary payments, you can face additional IRS and/or state underpayment penalties on top of the taxes you owe.
Underpayment Penalties
The IRS has a formula for calculating underpayment penalties. The formula is based on the amount by which you underpaid during a given quarter and the number of days the payment was late.
For the self-employed, the penalty is the federal short-term rate, plus 3%. So, the rate will fluctuate alongside the federal short-term rate.
Normally, the IRS will calculate your penalties for you on your tax return so you don’t have to calculate them yourself.
How Can I Avoid Penalties?
The IRS lays out the circumstances under which penalties can be waived. The main circumstance is all of the following applying to you:
- You are over 62 years old or have a disability
- You have a reasonable cause for not making your payment
- You did not willfully neglect your payment deadline
The other likely cause for a waiver would be if your missed payment:
- Was the result of a natural disaster
- Was the result of your death
- Was the result of another “unusual situation”
The IRS reserves the right to make the final decision on whether or not to waive your penalties.
If you think you may be eligible for a penalty waiver, you need to request one from the IRS using Form 2210. The form must be submitted with your tax return, alongside a written explanation for why you missed your payment.
Another way to avoid the underpayment penalties for W-2 wage earners, is to adjust your income tax withholding rate throughout the year. You can adjust their income tax withholding by changing the Form W-4 on file with their employer. The process to change your Form W-4 varies by employer, but essentially, if you report any amount of “Other Income” on the new W-4 form, more income tax will be withheld from your paychecks. If you reduce the “Other Income” amount, or add an amount to the “Deductions” line, then the amount of income tax withheld from your paycheck will be reduced.
If none of the above apply to you, there are no other ways of avoiding underpayment penalties.
We hope we covered everything you wanted to know regarding Quarterly Estimated Taxes, but please contact us if you have questions specific to your situation or if you want to find out how Cerebral Tax Advisors can help you maximize your contributions.