What is estimated tax?
Because the U.S. tax system operates on a pay-as-you-go basis, taxes must be paid as income is received rather than in a lump sum at the end of the year. If you are a freelancer, independent contractor, small business owner, or participate in the sharing economy but do not have an employer, you will need to make quarterly estimated tax payments to cover your tax obligation. In order to facilitate the collection of income not subject to withholding, the estimated tax method was devised. This enables self-employed taxpayers to estimate their income and self-employment tax for the year and pay the estimated tax in 4 installments.
Do I need to pay estimated tax?
If you’re in business for yourself and don’t have other income subject to withholding, you need to pay estimated tax throughout the year. Some income not subject to withholding includes: income from self-employment, the sharing/gig economy, and some rental activities.
You will need to make estimated tax payments if you answer “yes” to any of the following questions.
- Do you expect to owe more than $1,000 in taxes for the tax year after subtracting your withholding from the total amount of tax you expect to owe this year?
- Do you expect your income tax withholding (plus any estimated taxes paid on time) for the current year to be less than the lower of:
- 90% of the total tax due for the current year
- 100% of the total tax shown on the previous year return. To use this rule, there must have been a tax liability in the previous year.
How should I figure what I owe?
Unfortunately, knowing if you have to pay estimated taxes is the easy part. The real work is calculating how much you owe each quarter. To make this process clear, we’ll use an example for a freelancer called Debbie Door Dasher.
Debbie first estimates her expected adjusted gross income, deductions, and credits to arrive at her taxable income for the year. Debbie multiplies her taxable income by the percentage indicated for her tax bracket. This calculation gives Debbie her federal and state estimated income tax owed for the year.
We’ll assume Debbie earned more than $400 dollars this year and she’ll need to pay self-employment tax as part of her estimated tax payments. We’ll calculateher estimated self-employment tax owed for the year.
Self-employment tax is money the self-employed must pay to the federal government to fund their share of Medicare and Social Security. This tax must be paid if your net earnings total $400 or more during the tax year. It is separate from federal income tax and equals 15.3 percent of your self-employment income.
Debbie adds together her estimated income tax from step 1 and her estimated self-employment tax from step 2 then divides the total by 4 to calculate her quarterly estimated tax payments.
You can calculate your federal estimated tax payments in one of several ways:
When To Pay
Estimated tax payments are due on a quarterly basis.
Below are the 2018 quarterly estimated tax payment due dates:
January 1 – March 31
April 1 – May 31
June 1 – August 31
September 1 – December 31
January 15, 2019
How should I pay?
There are several methods to pay estimated taxes.
- Direct Pay (free and fast)
- Electronic Federal Tax Payment System (EFTPS)
- Personal Check or Money Order
- Credit or debit card through an IRS-approved processor. *
* card-provider fees may apply
What happens if I don’t pay?
If you don’t pay enough tax through withholding and estimated tax payments or you file late, you may be charged late payment fees and interest even if you are due a refund when you file your tax return.
- If you have income subject to withholding, check your withholding to ensure it is sufficient to avoid a tax underpayment penalty. The withholding tool can help you determine if you need to give your employer a new Form W-4.
- Adjust paycheck withholding (make changes to Form W-4) or the amount of estimated tax payments to avoid tax surprises at filing time.
- If you think you’ll make less this year than last year, pay at least 90% of the amount you paid last year. Or, if you think you will make more this year than last year, pay at least 110% of the amount you paid last year. This way, you can take advantage of safe harbor payments meaning, even if you owe more than 90% or 110% of what you paid last year, you won’t be penalized for the additional taxes not paid. You’ll still have to pay the extra taxes, just not any penalties on top of that amount.
- Quarterly estimated taxes include payments to the IRS and your state tax authority, if applicable.
- You can minimize big surprises at year’s end if you recalculate your estimated taxes at least once a quarter.
- Setup estimated tax payment due date reminders on your phone or laptop calendar so you don’t miss a payment.
- You're not just paying income tax. You must also pay self-employment tax, and your budget must cover both. As you receive income throughout the year, set aside 25% to 30% for estimated taxes.
- You don't have to wait until the quarterly estimated tax due dates to pay your taxes as a freelancer—you just can't go beyond these dates without incurring a penalty. If you're particularly flush one month, go ahead and pay your taxes early.
- If your income fluctuates throughout the year, paying estimated taxes can be difficult. If you’re filing taxes for a seasonal business, the IRS offers an “annualized” payment method to allow you to pay a certain percentage of each quarter’s earnings, rather than four equal payments.
- Create a separate account for taxes. Move money into the account once a week or every month so you know the money’s there when needed.
- If you have an over payment on one year’s tax return, you can use it to get a head start on estimated tax payments for the next year.
- Even if you expect a tax refund, you still need to promptly pay your quarterly estimated tax payment. If you don’t, the IRS might charge you an underpayment or late payment penalty.
- If you have a unique business model or tax considerations you don’t feel comfortable with, you may need to consult a qualified tax professional.
This content is developed from sources believed to be providing accurate information, and provided by Financial Planning Done Right. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.