Do I Need to Pay Estimated Taxes? An FAQ Cheat Sheet

Tax day is just about here, but a portion of taxpayers still have more tax deadlines in 2022 to worry about. Some side hustlers and newly self-employed taxpayers may be in for a surprise this tax season when they find out they have to now file and pay estimated tax payments.

What triggers this and are you penalized if you don’t file and pay your estimated taxes? Here is a FAQ breakdown of the estimated tax payment process so you know exactly what to expect each quarter.

Do I have to make estimated tax payments?

Taxes must be paid as you earn or receive income through the year. For most employed W2 taxpayers, this is done through withholding taxes on your paychecks. For contractors, the self-employed, and any income that does not have income tax withheld, this must be done through estimated tax payments.

Per the IRS: “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. Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and alternative minimum tax.”

Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.

If this is your first year with self-employment income or increased interest and dividend income, it’s important to review your requirements for quarterly estimates to avoid facing penalties and interest.

You don’t have to pay estimated tax for the current year if you meet all three of the following conditions.

• You had no tax liability for the prior year.
• You were a U.S. citizen or resident for the whole year.
• Your prior tax year covered a 12-month period.

 

How are estimated taxes calculated?

You are required to prepay 90% of next tax year’s bill or 100% of the prior year tax bill (110% if your adjusted gross income is over $150,000) to avoid underpayment penalties. If you do not, penalties for underpayment may apply to you in addition to the tax surprise facing you next April.

 

When are estimated taxes due?

For estimated tax purposes, the year is divided into four payment periods, each with a specific payment due date. If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty, even if you are due a refund when you file your income tax return.

Quarterly estimated payments are due four times a year. The dates are:

• First Quarter – April 15 (Same date that income tax returns are due.)
• Second Quarter – June 15
• Third Quarter – September 15
• Fourth Quarter – January 15 of the next year. With careful tax planning, it may benefit some taxpayers to pay their fourth-quarter taxes prior to December 31.

If the 15^th falls on a weekend or holiday, the date is moved to the next business day. Sign up for Alloy Silverstein’s email list to be reminded of quarterly estimated payment due dates.

 

IRS Form 1040-ES

Use Form 1040-ES to figure and pay your estimated tax.

 

What payment methods are accepted for estimated taxes?

Can you pay estimated taxes onlinqqe? By credit card? What about cash? The IRS has many available payment options for individuals and businesses looking to submit their quarterly estimated taxes.

First, it is recommended to individual taxpayers to create an online IRS.gov account to view the amount you owe, your payment history, and any scheduled or pending payments.

To create/view your account and to access all payment options, visit:  https://www.irs.gov/payments

IRS payment options include:

• Electronic — Online via your IRS.gov account (individuals only).
• ACH Transfer — Individuals can use Direct Pay to pay the IRS directly from their bank account. Payments can be scheduled for up to 12 months in advance.
• Credit — Pay by credit card or debit card (processing fees apply).
• Digital Wallet — Pay electronically by Pay Pal or Click to Pay (processing fees may apply).
• EFTPS — Enroll to make payments via Electronic Federal Tax Payment System (EFTPS).
• Same-Day Wire — Bring this completed form to your financial institution, but note that bank fees may apply.
• Check or Money Order — Can send your estimated payment through U.S. mail. Make sure to include your completed 1040-ES payment voucher.
• Cash — For taxpayers who want to pay as securely as possible or do not have a bank account or credit card, the IRS accepts cash payments at certain retail partners or in-person IRS Taxpayer Assistance Centers. View their cash payment page for more options.
• E-File Electronic Funds Withdrawal — When e-filing your return, an integrated e-file/e-pay option is offered only when filing your federal taxes using tax preparation software or through a tax professional. Using this payment option, you may submit one or more payment requests for direct debit from your designated bank account.
• Installments — Set up an agreed-upon payment plan with the IRS.

 

What if I can’t afford to submit estimated tax payments?

If you’re facing financial hardship, taxpayers may be eligible to ask for a temporary collection delay until their financial situation improves.

Another option is to initiate a payment plan. Visit the above IRS payments page in order to apply for and set up a payment plan and installment agreement in order to pay your balance over time.

 

What if my estimated tax payments are wrong?

While you can receive a penalty if your estimated payments are largely underpaid, an overpaid amount can be returned to you as a refund when you complete your annual income tax return the next year. However, too large of an overpayment can also result in a penalty. This is why it is important to conduct a tax projection and planning session with your accountant and advisor.

Should it be needed, submitted estimated tax payments can be amended. To change or amend your estimated tax payments, refigure your total estimated tax payments due (see the 2022 Estimated Tax Worksheet). Then, to figure the payment due for each remaining payment period, see Amended estimated tax in chapter 2 of Pub. 505.

 

What if my estimated taxes are late?

The IRS suggests you avoid additional penalties by filing and making a payment by the due date, even if you can’t make the full tax payment.

 

What can cause an unexpected estimated tax payment obligation?

How do you know if you need to place another check in the mail? Here are triggers that suggest you may wish to consider sending in a quarterly estimated tax payment.

1.  You needed to file quarterly estimated tax payments last year or your current tax return requires an additional tax payment in excess of $1,000.
2.  You receive income that does not have taxes withheld. Common sources of this type of income are Social Security Benefits, part-time jobs, and self-employment income.
3.  You have rental property, investment income, or interest income. In this case you may wish to consider calculating your estimated tax obligation for next year to determine if estimated tax payments are required.
4.  New tax changes could impact your tax bill. If you and your spouse both work, the marriage penalty and additional taxes for middle and upper income households could impact the amount owed next year.
5.  Any life events in your near future? Remember certain events such as marriage, divorce, or the birth of a child can change your tax obligation up or down. Perhaps you expect earnings from a small business or investment to impact your taxable income during the year.

If you are a W2 employee and ended up with a surprise tax bill because of under-withholding, you may want to revisit your Form W-4. Our affiliate, Abacus Payroll, Inc. has a complimentary W4 Assistant Calculator.

Special COVID-19 situations that may trigger the need for estimated payments this year

The pandemic made the last two tax years a little more complicated, especially if the following situations happened to you in 2021:

• Received unemployment. Check to see if either federal or state taxes were withheld from unemployment compensation payments you received. If not, you may need to account for these payments with your fourth quarter estimated tax payment.
• Had unusual business income. If your business was hit by the pandemic, you may find your withholdings were either too much or too little compared to normal. Run a quick tax projection to make sure you are adequately covered from underpayment penalties.
• Picked up side jobs to make ends meet. These part-time gigs often create income without proper tax withholdings.

 

How do you avoid a penalty?

There are three ways to avoid penalties and the ire of the IRS:

1. On-time filings – There is a penalty for late filings. By submitting a payment, even if it’s not the full amount, at least you won’t face a fee for late tax filing. Since these tax deadlines come four times a year, late fees can quickly add up.
2. Don’t underpay estimated tax – If self-employed, a penalty can occur if you do not have proper withholdings throughout the year. If an estimated tax payment for a previous period is less than one-fourth of your amended estimated tax, you may owe a penalty when you file your return. A fourth quarter catch-up payment may not help avoid an underpayment penalty if you didn’t pay enough taxes in prior quarters.
3. Increase withholdings on Form W4 – Even if you’re note self-employed and are not yet required to make estimated payments, if you have a large tax liability come tax season because you do not have proper tax withholdings, you could be subject to an underpayment penalty. Learn from your past year’s mistake and adjust your Form W4 as soon as possible.

You may be charged a penalty if you don’t pay enough tax through withholding and estimated tax payments or if your estimated tax payments are late, even if you are due a refund when you file your tax return. The penalties are calculated based on the amount of tax owed, so it may be a very nominal amount or could be a much steeper fee depending on your individual situation.

Federal Tax “Safe Harbor Rules”

1. If your federal tax obligation is less than $1,000 no underpayment penalties apply.
2. You withhold at least 90% of this year’s federal tax obligation.
3. You withhold at least 100% of last year’s tax obligation
4. If your gross income is greater than $150,000 ($75,000 if you are married filing separately) you must withhold the smaller of 90% of this year’s tax obligation OR 110% of the tax shown on last year’s tax return.

 

Are estimated tax payments only at the federal level?

No — don’t forget about your state obligations .With the exception of a few states, you are often required to make estimated state tax payments when required to do so for your federal tax obligations. Consider conducting a review of your state obligations to ensure you meet these quarterly estimated tax payments as well. If you receive income from multiple states, this may require multiple state returns and estimates.

 

Are there exceptions?

Estimated tax requirements are different for corporations, farmers, fishermen, and certain higher income taxpayers. Publication 505, Tax Withholding and Estimated Tax, provides more information about special estimated tax rules.

As a self-employed taxpayer, is there anything else I need to know?

As a self-employed individual, remember to also pay your Social Security and Medicare taxes, not just your income taxes. Creating and funding a savings account for this purpose can help avoid a cash flow hit each quarter when you pay your estimated taxes.

 

Contact Us

Tax season may be coming to an end, but tax planning is a year-round venture. Request a planning meeting with an Alloy Silverstein CPA to see how your business goals can be pursued, while minimizing tax liability.

 

Additional Sources:
IRS.gov
Alloy Silverstein Financial Services, Inc., FMG