What Is Estimated Tax?
Estimated tax is a quarterly payment of taxes for the year based on the filer’s reported income for the period. Most of those required to pay taxes quarterly are small business owners, freelancers, and independent contractors. They do not have taxes automatically withheld from their paychecks, as regular employees do.
Estimated taxes may be made for any type of taxable income that is not subject to withholding. This includes earned income, dividend income, rental income, interest income, and capital gains.
The Internal Revenue Service (IRS) requires quarterly estimated tax payments to be filed by those who have income that is not subject to automatic withholding. The taxpayer then files the usual tax paperwork for the full year and pays the balance due or requests reimbursem*nt for an overpayment.
Key Takeaways
- The quarterly filing system requires people and businesses to pay an estimate of the amount they will owe in taxes for that period.
- They also file annual tax returns that determine their exact total taxes due.
- Quarterly filing is required of those who do not have taxes withheld from their incomes automatically.
The IRS often extends filing and payment deadlines for victims of disasters like hurricanes, floods, and wildfires. If you've been affected by such a disaster, you can consultIRS disaster relief announcementsto determine your eligibility for an extension.
Understanding Estimated Tax
Everyone is required to pay the federal government taxes as they earn or as they receive income during the year. In other words, income taxes are pay-as-you-go.
Those who are employed have taxes withheld from their paychecks by their employers based on the W-4 forms the employees complete. Others need to make these payments directly to the government in the form of an estimated tax, rather than waiting until the end of the year to pay when they file their annual tax return.
People who are self-employed, independent contractors, investors who receive dividend income and generate capital gains, bondholders who get interest income, writers who earn royalties on their work, and landlords with rental income are all examples of taxpayers who must estimate the amount of taxes they owe to the government and pay that amount.
Other examples of income liable for estimated tax include taxable unemployment compensation, retirement benefits, and any taxable portion of Social Security benefits received.
Estimated taxes are usually paid on a quarterly basis. The first quarter is the three calendar months (Jan. 1 to March 31). The second "quarter" is only two months long (April 1 to May 31). The third is the next three months (June 1 to Aug. 31), and the fourth covers the final four months of the year.
These installment payments are generally due on April 15, June 15, and Sept. 15 of the current year and on Jan. 15 of the following year.
Installments for estimated tax payments are due on April 15, June 15, and Sept. 15 of the same year and Jan. 15 of the following year.
If the estimated taxes that are paid do not equal at least 90% of the taxpayer’s actual tax liability (or 100% or 110% of the taxpayer’s prior-year liability, depending on the level of adjusted gross income), interest and penalties are assessed against the delinquent amount.
No tax is payable if an individual filer’s net earnings are less than $400. If their net earnings are above $400, an estimated tax must be paid on the entire amount. Individuals must still file a tax return even if they earned less than $400, as long as they meet certain eligibility requirements.
Estimated Tax for Business Owners
Individuals, including sole proprietors, partners, and shareholders of S corporations, must make estimated tax payments on business ownership earnings if the total tax on built-in gains, excess net passive income tax, and investment credit recapture tax is $1,000 or more.
Corporations must pay estimated tax if the business is expected to have at least $500 in tax liability.
In addition, employees who had too little tax withheld and thus owed taxes to the government at the end of the previous year are responsible for making estimated tax payments.
A business owner who reports income on Schedule C and, at the same time, works for an employer who has withheld tax may be able to increase the employer’s withholding so that it equals the person's tax liability for the entire year. In this case, the person will not need to pay estimated taxes on the side business.
IRS Form 1040-ES is used to calculate and pay estimated taxes for a given tax year. A taxpayer who had no tax liability for the prior year, was a U.S. citizen or resident for the whole year, and had the prior tax year cover a 12-month period, does not have to file Form 1040-ES.
FAQs
If the amount of income tax withheld from your salary or pension is not enough, or if you receive income such as interest, dividends, alimony, self-employment income, capital gains, prizes and awards, you may have to make estimated tax payments.
How do you explain estimated taxes? ›
Estimated tax is a quarterly payment of taxes for the year based on the filer's reported income for the period. Most of those required to pay taxes quarterly are small business owners, freelancers, and independent contractors. They do not have taxes automatically withheld from their paychecks, as regular employees do.
Why does TurboTax say I need to pay estimated taxes? ›
In most cases, to avoid a penalty, you need to make estimated tax payments if you expect to owe $1,000 or more in taxes for the year—over and above the amount withheld from your wages or other income.
How do you know if you make enough to pay taxes? ›
As an example, somebody under the age of 65 filing as a single taxpayer will only be required to file if his or her income is $13,850 or more. Why $13,850? Simple—that is the value of the standard deduction for a single taxpayer (including one exemption) in 2023.
What happens if you don't pay enough estimated taxes? ›
Failure to keep up with your tax payments or withholding may cause the IRS to assess a penalty for underpayment of estimated taxes. The amount of the penalty is determined by the balance still owed after you've filed your annual tax return. The IRS charges its 8% interest rate until the balance is paid in full.
Is it okay to pay all estimated taxes at once? ›
Technically, yes. You can pay all of your quarterly taxes for the upcoming year by the first quarterly deadline of the year in April. But it might not be an accurate amount if you don't know exactly how much you'll make for the rest of the year—and that could lead to an underpayment penalty.
How do I avoid penalties for underpayment of estimated taxes? ›
Generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and refundable credits, or if they paid withholding and estimated tax of at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is ...
Why am I being asked to pay estimated taxes? ›
Figuring when and how to pay
But if you are self-employed, or if you have income other than your employment wages, you may need to pay estimated taxes each quarter. You may owe estimated taxes if you receive income that isn't subject to withholding, such as: Interest income. Dividends.
When not to pay estimated taxes? ›
According to the IRS, you don't have to make estimated tax payments if you're a U.S. citizen or resident alien who owed no taxes for the previous full tax year.
What triggers the IRS underpayment penalty? ›
If you owe more than $1,000 when you calculate your taxes, you could be subject to an underpayment of estimated tax penalty.
You must pay taxes on up to 85% of your Social Security benefits if you file a: Federal tax return as an “individual” and your “combined income” exceeds $25,000. Joint return, and you and your spouse have “combined income” of more than $32,000.
What is the 110% rule for estimated tax payments? ›
if you pay at least 90% of the tax obligation for the current year. if you pay an amount equal to 100% (if your adjusted gross income for the year is over $150,000 then you'll need to pay 110%) of your taxes for the prior year.
At what age is Social Security no longer taxed? ›
Social Security tax FAQs
Social Security income can be taxable no matter how old you are. It all depends on whether your total combined income exceeds a certain level set for your filing status. You may have heard that Social Security income is not taxed after age 70; this is false.
Can the IRS penalize you for not paying estimated taxes? ›
The Underpayment of Estimated Tax by Individuals Penalty applies to individuals, estates and trusts if you don't pay enough estimated tax on your income or you pay it late. The penalty may apply even if we owe you a refund. Find how to figure and pay estimated tax.
Is it bad to not pay quarterly taxes? ›
If you don't pay your estimated taxes on time (or if you don't pay enough), the IRS can charge you a penalty. The amount you owe increases the longer you go without payment. The failure to pay penalty is 0.5% of the unpaid taxes for each month or part of a month you don't pay, up to 25% of your unpaid taxes.
What happens if you pay too much estimated tax? ›
If you've overpaid your taxes, the IRS will issue you a refund when you file your taxes for the year. This is the easiest way to know that you've paid more into taxes than necessary.
What is an example of an estimated tax payment? ›
Example: You calculate that you need to pay $10,000 in estimated taxes throughout the year, and you don't make your first payment until June 15 (when the second estimate is due), so your first payment will be $5,000. Your September payment and your January payment will be $2,500 each.
Why would you pay estimated taxes? ›
People who aren't having enough withheld. The IRS says you need to pay estimated quarterly taxes if you expect: You'll owe $1,000 or more in federal income taxes this year, even after accounting for your withholding and refundable credits (such as the earned income tax credit).
What is the 90% rule for estimated taxes? ›
Estimated tax payment safe harbor details
The IRS will not charge you an underpayment penalty if: You pay at least 90% of the tax you owe for the current year, or 100% of the tax you owed for the previous tax year, or. You owe less than $1,000 in tax after subtracting withholdings and credits.
How do I avoid 110% estimated tax penalty? ›
You may avoid the Underpayment of Estimated Tax by Individuals Penalty if:
- Your filed tax return shows you owe less than $1,000 or.
- You paid at least 90% of the tax shown on the return for the taxable year or 100% of the tax shown on the return for the prior year, whichever amount is less.
