Hey guys, it’s Bette Hochberger, CPA, CGMA here, and for today’s #TaxTipTuesday, I’ll be discussing estimated tax payments and how they work. So, estimated tax payments can often seem like a tricky aspect of financial management, especially for those new to self-employment or with changing income streams. However, with a little insight into how they work, you can manage them effectively and avoid potential penalties.
What Are Estimated Tax Payments?
Estimated tax payments are periodic advance payments made to the IRS on income that is not subject to withholding taxes. This typically includes income from self-employment, interest, dividends, alimony, rent, and gains from the sale of assets. The U.S. tax system operates on a “pay-as-you-go” basis, meaning taxes should be paid as income is earned or received throughout the year. Therefore, if you expect to owe at least $1,000 after deducting withholding and refundable credits, making estimated payments is essential.
How Do They Work?
The IRS requires these payments to be made quarterly: generally in April, June, September, and January of the following year. Calculating the payment amount involves estimating your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. This can be done using Form 1040-ES, which includes a worksheet for this purpose. It’s important to keep accurate records and adjust your estimates if your income changes to ensure you’re not underpaying or overpaying.
Penalties for Underpayment
Failing to pay your estimated taxes on time or underpaying can result in penalties. The IRS imposes an underpayment penalty if you don’t pay enough throughout the year, either through withholding or estimated payments. The penalty is essentially an interest charge on the amount you should have paid but didn’t. However, you can avoid penalties if you owe less than $1,000 in tax after subtracting withholdings and refundable credits, or if you’ve paid at least 90% of the tax for the current year or 100% shown on your return for the previous year, whichever is smaller.
By understanding and managing your estimated tax payments, you can ensure compliance with tax laws and avoid unnecessary penalties. Whether you’re a freelancer, business owner, or earn additional income outside of traditional employment, staying informed and proactive with your obligations is crucial for financial stability.
I hope you learned something new today. As always, stay safe, and I’ll see you next time!
