Jul 15, 2021Quarterly Tax Estimates: How to calculate and who needs to pay
As an employee of a business, you are expected to pay income tax to the IRS. To ensure the IRS receives its payments, employers will withhold income tax from each paycheck. As your employer is diligent in retaining these funds, you may receive a nice tax refund during tax time.
Who Needs to Make Quarterly Estimates?
However, self-employed individuals and individuals with supplementary income other than their primary salary may need to pay estimated income taxes each quarter to ensure an accurate tax bill. Many people have made the mistake of reconciling income tax only at the end of the year, just to realize they owe substantially more than expected. If you receive income from these sources, you may be required to estimate tax payments:
- Interest income
- Gains from sales of stock or other assets
- Earnings from a business
- Alimony that is taxable
Note that not everyone in these categories needs to pay income tax. Generally though, you’ll want to pay as you go. If you underpay throughout the year, you may have to pay what you owed in income tax and a fee for underpayment.
To assess whether or not you need to make quarterly tax estimates, answer these questions:
- Do you expect to owe less than $1,000 in taxes for the tax year after subtracting your federal income tax withholding from the total amount of tax you expect to owe? If so, you won’t need to make quarterly estimates.
- Do you expect over 90% of your total tax payments to be comprised of your federal income tax withholding? If so, you won’t need to make quarterly estimates.
- Do you anticipate that your income tax withholding will be at least equal to total tax on your previous year’s return? If so, no need to make estimated tax payments.
- If your adjusted gross income was over $150,000 last year (or $75,000 if married and filing separately), do you anticipate that your income tax withholding will be at least 110% of the total tax you paid for the previous year? If so, you’re not required to pay quarterly tax estimates.
If you don’t meet the criteria above, the IRS requires you to estimate quarterly tax payments using Form 1040-ES. To avoid a tax penalty, you must show that your total tax payments during the year meets at least one of the requirements above.
What tax payment strategy should I use?
The most fool-proof option is to pay 100% of the previous year’s income tax if you make less than $150,000, or to pay 110% of the previous year’s income taxes if you make more than $150,000 (or $75,000 if married and filing separately). If you satisfy these requirements, you won’t be obligated to pay an estimated tax penalty, regardless of how much you actually owe with your tax return.
If you expect to earn less than last year, you can choose to pay 90% of your estimated current tax year bill. This option is great for those wanting to keep money in their pockets during the tax year, but can be damaging if the estimates aren’t done correctly. If you end up paying less than 90% of the total tax owed for the current tax year, you’ll face an underpayment penalty. So, if you choose to go this route, be sure to err on the side of more than 90% rather than less.
Alternatively, if you expect your income tax to be more this year than last, you can simply estimate 100% of this year’s tax payments and pay each quarter.
How do I calculate what I owe?
Any time tax estimates are involved, Nimbl recommends consulting a tax expert to receive the best help possible. However, we’ll offer a few tips here to help you get started.
As you begin working through form 1040-ES, you’ll want reliable sources to pull your estimates from. Here’s what you’ll need to have ready:
- Your previous year’s tax return. Use your previous year’s return as a template for each form of income and each type of deduction you expect on your current year’s return. Look at the total tax you paid if you are aiming for 100% of 110% of the previous year’s return.
- A record of estimated tax payments you’ve already made. As you estimate upcoming payments, you’ll want to factor in payments already made.
One method of quarterly tax estimates is you apply your previous year’s refund to the next year’s taxes. Instead of celebrating some extra pocket change with a new toy or fun trip, use the funds to begin paying off the next round of taxes. That way, you’ll have more cash flow during the year rather than one large lump sum during tax time.
What are the consequences if I don’t pay?
The main penalty for not paying the appropriate amount, or failing to pay any estimates at all, is an underpayment penalty issued by the IRS. The exact amount depends on how much is owed and the length of time the payment has been overdue.
How can I get started?
The best way to be proactive about quarterly estimates is to consult a tax expert. At Nimbl, we offer on time filings for quarterly estimates for our clients. Reach out today if you’re interested in receiving help with these estimates.