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What Are Estimated Tax Payments?

Estimated taxes may sometimes feel like a secondary topic of discussion during tax planning meetings, but they shouldn’t be. Figuring accurate estimates is important to avoid a large tax bill at the end of the year, but they’re so much more than that. Because estimates require you to both reflect on the past and look to the future, estimated tax calculations can serve as proactive tax planning tools, helping you shape business practices and build strategies to reach your goals.

What Are Estimated Tax Payments?

Estimated taxes are how individuals pay federal and state income tax on income that is not subject to withholding.

As part of payroll tax law, employers are required to withhold income tax from their employees’ paychecks. But self-employed people and people who earn passive income don’t have an employer to withhold taxes on their behalf; they must calculate and pay those taxes themselves. These payments are known as estimated taxes, or quarterly estimates.

Who Is Required to Pay Estimated Taxes?

Individuals should pay federal estimated taxes if they expect to owe $1K or more of tax when they file their return. This applies to all individuals, regardless of employment status, which means that all of the following people may be expected to make estimated tax payments:

  • Sole proprietors
  • Small business owners
  • Independent contractors
  • Gig workers
  • Partners in partnerships
  • S corporation shareholders
  • Individuals who report interest, dividends, rents or royalties where tax is not withheld
  • Recipients of unemployment compensation
  • Recipients of taxable social security benefits
  • Anyone else whose withholdings will not cover all or most of their tax liability

Individuals will not be required to make quarterly estimates if they meet the following three conditions:

  1. They were a US citizen or resident for the entire year.
  2. They reported no tax liability for the prior tax year.
  3. The prior tax year covered a 12-month period.

When Are Estimated Taxes Due?

Individuals that fall into the categories above must pay estimated tax payments in four equal installments:

1st Quarterly PaymentApril 15
2nd Quarterly PaymentJune 15
3rd Quarterly PaymentSeptember 15
4th Quarterly PaymentJanuary 15 of the following year

Over- or underpayments will be trued up when taxpayers calculate and file their returns.

How Do I Pay Estimated Taxes?

Estimated taxes can be paid using the estimated tax payments form, IRS Form 1040-ES.

Estimated taxes should be paid at least quarterly, but you can send payments to the IRS more frequently you wish. For some taxpayers, it’s easier to manage cash if they make smaller monthly payments. The IRS Electronic Federal Tax Payment System website allows you to schedule payments at any frequency that you choose, or you can send paper checks whenever you’re ready to make a payment.

How Are Estimated Taxes Calculated?

Total estimated taxes for the year should cover all remaining tax liability not covered by withholdings. This is a straightforward calculation if you know exactly what your income, deductions and credits will be for the year: simply divide your anticipated tax liability by four to determine each quarterly payment. But people who are self-employed or have income streams that vary must put in a bit more effort to figure their quarterly payments.

Estimating tax liability based on income that you haven’t yet earned is tricky, so most people begin their estimated tax calculations with prior year tax data. With help from an accountant, they will adjust the prior year’s tax return for current year changes to estimate future tax liability. A good tax planning software will help with this calculation by asking some of the following questions:

  • Did you move, purchase or sell a home?
  • Did you get a new job or start a new business?
  • Do you anticipate your income will change? If so, from what sources and by how much?
  • Did your filing status change due to a marriage, divorce or separation?
  • Did you have or adopt a child?
  • Did your adult children surpass the age at which you can claim them as dependents?
  • Are you eligible for new tax credits or deductions this year?
  • Will new tax regulations affect your ability to claim a credit or deduction?

After adjustments are made to prior year numbers, the tax planning software can divide the resulting annual tax liability into four equal installments. As the year goes on, taxpayers can easily tweak their remaining payments to reduce the likelihood their estimates will be underpaid at the end of the year.

What If I Don’t Pay Enough Estimated Taxes?

Those who don’t pay estimated taxes when required will be assessed penalties and interest. There are two main ways the IRS calculates penalties related to tax payments:

Penalty for Underpayment of Estimated Tax

An underpayment of estimated tax penalty is applied if you didn’t make sufficient estimated tax payments. In general, you will owe this penalty if your total estimated tax payments + withholdings didn’t equal at least the smaller of:

  • 90% of current year tax due, or
  • 100% of prior year tax due

You will not be assessed a penalty if you owe less than $1K at the end of the year after all estimates and withholdings are applied.

The underpayment penalty is calculated separately for each installment and will grow depending on how long quarterly payments have been overdue. Generally, the maximum penalty cannot exceed 25% of the underpaid amount.

You may still owe an underpayment penalty even if you’ve caught up on estimated payments by the time you file your return. Because the calculation is made separately at each installment, you may owe taxes on first- and second-quarter estimates even if you make up for those shortcomings in the third and fourth quarters.

Failure to Pay

A failure to pay penalty is a bit different. This is assessed if you don’t pay all taxes by the due date (which is April 15 for most individuals). This penalty is 0.5% of the unpaid taxes for each month the tax remains unpaid, unless you are on a payment schedule with the IRS, at which point the penalty is reduced to 0.25%. The penalty cannot exceed 25% of unpaid tax.

Do Corporations Owe Estimated Taxes?

Yes. Corporations must pay estimated taxes if they expect to owe $500 or more of tax when they file their return. Corporations pay estimates using Form 1120-W.

What About State Taxes?

States that assess annual income tax also require their taxpayers to make quarterly estimated payments. Generally, these estimated payments align with federal due dates, but not always. For example, in 2020, some states did not extend first- or second-quarter estimated tax payments when the IRS extended both to July 15, 2021, in response to the coronavirus pandemic. Look to your state to determine when your estimated taxes are due.

Estimated taxes are just that — estimates. You may not get it perfect every time, and that’s OK. But if you have proper tax planning software, you can ensure your estimated taxes are as accurate as possible. If you want to learn more about Corvee’s Tax Planning software, reach out to us today to request a demo.

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