As a small business owner and freelancer, I’m amazed by how quickly my employed friends get their taxes done. Their employers withhold taxes year-round, and all these friends have to do is file by the IRS tax deadline to get a tax refund. But if, like me, you don’t have a human resources department pulling tax money out of your paycheck for you, you have to pay estimated taxes four times a year.
This system helps the government maintain a reliable schedule of when money is coming in, and it protects you from having to cough up all the dough at once. While it’s a little extra work, filing your estimated tax payments each quarter helps you stay on top of your taxes.
What Are Estimated Tax Payments?
When you work full-time, your company will withhold federal, state, and any local taxes from your paycheck automatically. With each pay cycle the money automatically goes to the IRS, so when tax filing season comes around, you just let the IRS know how much you’ve already sent and then either send the rest or wait for your refund. If you’re in business for yourself, however, you need to be your own HR department and regularly send the IRS money.
Paying estimated taxes requires you to estimate in advance how much you expect to owe the government in taxes for the current tax year. You then send in four quarterly payments that together total the amount. The dates quarterly payments are due by fall on or around the middle of the months of April, June, September, and January. For the 2016 tax year, estimated tax payments are due April 18, 2016; June 15, 2016; September 15, 2016; and January 17, 2017.
If you don’t make quarterly estimated tax payments and are required to, the IRS will hit you with an underpayment penalty. To avoid penalties, you need to know if you’re responsible for estimated taxes, and how to determine and send your payments efficiently.
Do You Need to Pay Estimated Taxes?
If you fall into one of these two groups, you most likely need to make estimated tax payments:
1. Self-Employed Full-Time Workers and Small Business Owners
If you file as a sole proprietor, S-Corporation shareholder, partner, or self-employed, very likely you need to pay estimated taxes on a regular basis.
2. Freelancers with a Regular Job that Withholds Taxes
If you have a full-time job with tax withholding but also work on the side and either receive a 1099-MISC or have clients or customers pay you directly, you need to determine how much of your income is untaxed. If your freelance work constitutes a significant portion of your income, you should probably pay estimated taxes. A good rule of thumb is that if your side income doesn’t come to more than 10% of your gross income (earnings before taxes), you’re probably not going to need to make estimated tax payments.
How to Estimate Your Taxes
Plenty of tax preparation programs provide you with an estimate of the quarterly payments you need to make, as well as vouchers to send in to the IRS with those payments, once you file with them. Otherwise, follow the IRS instructions for Form 1040-ES to determine how much you should pay in estimated taxes and to create vouchers if you choose to send those payments in by mail.
You may be able to pay different amount throughout the year depending on how you receive your income. To avoid penalties, be sure to pay the minimum amount required for the quarter by the quarter’s due date. You can also make more than four estimated tax payments throughout the year by copying an unused payment voucher, if you choose.
How to Pay
You have a range of options for submitting payments. You can pay online by debit or credit card or by using the EFTPS system (you have to enroll), or pay by phone (by debit, credit, or EFTPS), or by mail.
Registering with EFTPS isn’t complicated: You just need a bank account, social security number or employer identification number, and a mailing address. You must use the mailing address that the IRS has on file, and they’ll mail you a PIN in about a week. Using that PIN, you can get into their website anytime to schedule a payment. Once you set up your bank account with EFTPS, you can schedule withdrawals.
When to Pay
You should pay taxes on the earnings from each quarter after the quarter has ended. However, the quarters aren’t equal – don’t let the June deadline surprise you.
Estimated tax payment deadlines are below:
- First Quarter (January 1 to March 31): Estimated taxes due April 18, 2016
- Second Quarter (April 1 to May 31): Estimated taxes due June 15, 2016
- Third Quarter (June 1 to August 31): Estimated taxes due September 15, 2016
- Fourth Quarter (September 1 to December 31): Estimated taxes due January 17, 2017
Escaping the Underpayment Penalty
You may be liable for an underpayment penalty if you pay less than 100% of your tax liability by the tax filing deadline. You can avoid the penalty if you meet one of the exceptions below:
- You’ve already paid (through estimated tax payments or withholding) the lesser of the amount you paid in taxes last year or 90% of what you owe this year. The one exception is that you must pay 110% of last year’s tax liability if your gross income was at least $150,000.
- Your tax liability is $1,000 or less for the entire year.
- You had no tax liability last year.
- Your total withholding for the year (estimated payments you made) is within $1,000 of your total tax liability on the deadline.
If you’re a “better safe than sorry” taxpayer, and you’re concerned about underpayment, you can either increase your federal income tax withholding allowances if you have a full-time job, or overestimate your quarterly tax payments if you’re self-employed. The IRS doesn’t charge you a penalty for sending them too much money, of course.
In the end, the estimated tax process prevents you from facing a frightening tax bill in April. While it might be a little inconvenient throughout the year, estimated tax payments can be a great tool to help self-employed people and small-business owners budget their tax payments.
Are you making quarterly estimated tax payments? What tools do you use to estimate your tax due and make sure you don’t miss deadlines?