Estimated Taxes: What You Need to Pay and When

Most people think of April 15th as the due date for taxes, but the reality is that the IRS wants its cut as soon as you get paid. If your income isn’t covered by income tax withholding, you need to make estimated tax payments.

Who has to pay estimated taxes?

You need to pay estimated taxes if you will owe $1,000 or more when you file your tax return. You may not need to pay estimated taxes if you had no income or tax liability the previous year, but it’s good to do anyway to avoid a surprise tax bill.

Common reasons for having to pay estimated taxes include running your own business or having a gig economy side gig that classifies you as an independent contractor like being a rideshare driver, grocery shopper, or sports official.

What happens if you don’t pay estimated taxes?

If you don’t pay estimated taxes, there are two possible penalties depending on when you actually pay.

Missed or Late Quarterly Payment

The underpayment of or failure to pay estimated tax penalty applies between the estimated tax payment due date and your tax return filing due date. This is an interest charge. The rate is about 2-3% higher than the current federal funds rate depending on rounding and when it was last changed.

Not Paying By Your Filing Deadline

The failing to pay penalty applies if you don’t pay your taxes by your tax return due date. The penalty is 0.5% per month of the outstanding balance. Interest charges also apply on top of this penalty.

How much should your estimated tax payments be?

Your estimated tax payments depend on your income and business type.

  • Default Rule: Most people can avoid estimated tax penalties by paying at least 90% of their current year tax or 100% of their previous year tax.
  • High Income: If your AGI is greater than $150,000 ($75,000 if married filing separately), you must pay either 90% of your current year tax or 110% of your previous year tax to avoid estimated tax penalties.
  • Farmers or fisherman: If at least 2/3 of your income is from farming or fishing, you can avoid estimated tax penalties by paying either 2/3 of your current year tax or 100% of your previous year tax.
  • Household employers: If you have a household employee, include their household employment taxes when calculating your estimated tax payments.

Most people make four equal payments. If your income is uneven, you can annualize your income to match your estimated tax payments to when you actually earned the income. This requires extra paperwork and usually isn’t worth it unless your income is highly variable.

When are estimated taxes due?

Estimated taxes for calendar year filers are due in quarterly installments on the following dates.

  • April 15th
  • June 15th
  • September 15th
  • January 15th (for the 4th quarter of the previous year) or skip this payment if you file your tax return and pay your balance due by February 1st

See Coronavirus Tax Relief for special extensions for 2020.

Note that the deadline may extend by a day or two if it falls on a weekend or federal holiday.

The easiest way to make estimated tax payments is to make four equal payments on those dates. If you don’t pay the full installment by the quarterly due date, you’ll owe an underpayment of estimated tax penalty. This penalty is smaller than the penalty for not paying in full by your tax return due date, and some people view it as a reasonable interest rate to wait to pay until April 15th. However, depending on your level of financial discipline, you may find it easier to go ahead and pay to avoid being short on funds later.

What income requires quarterly tax payments?

Estimated tax payments cover your total tax liability. Therefore, you should consider all of your income when calculating your estimated tax payments. This includes:

  • Wages (usually covered by employer withholding).
  • Self-employment income.
  • Farming and fishing income.
  • Bank interest.
  • Investment dividends and capital gains.
  • Taxable alimony.

How do you calculate estimated tax payments if you have withholding at a W-2 job?

If your employer withholds income tax, that withholding counts towards your estimated tax obligation. That’s why most employees don’t have to worry about estimated tax payments.

If you have a side job or rental property that only makes up a small portion of your income, you may be able to increase your withholding to avoid having to make a separate estimated tax payment.

To figure your estimated tax payments when you have withholding, take your total tax liability, subtract your expected withholding, and the difference is your estimated tax payment.

Is it better to use this year’s or last year’s income?

It is almost always easier to use last year’s income because all you need to do is divide the tax liability on your last tax return by four and make four equal payments. However, this method could leave you short if your income increases. To avoid this, use a tax calculator to estimate your current tax year liability and either set aside the additional amount in a savings account or make an extra estimated tax payment.

If your income decreases, you have the option to switch to the current-year method later in the year.

What if you pay too much?

If you pay too much because your income went down or you overestimated how much you need to pay, you can receive a refund when you file your final tax return just like you would if your employer withheld too much. You can also opt to apply your refund to your estimated payments for the next tax year.

There is no way to get an early refund if you significantly overpay your estimated taxes. If your income is unpredictable, you may

Where do you send payments?

The IRS has a number of payment options. The easiest option is to set up an account with EFTPS because you can schedule your payments in advance and have them automatically withdrawn from your bank account on the due date. Note that the initial EFTPS setup takes a few weeks because the IRS sends a PIN by mail that you must have to log in to your account.

To make payments by mail, fill out Form 1040-ES and send your payment along with the payment voucher to the address listed on the form.

Payments by credit card are possible if you’re short on funds. However, the approximately 2% processing fee combined with possible interest are probably greater than the IRS penalties as long as you’ll be able to pay your full tax liability by April 15th.

What’s the best way to handle quarterly tax payments?

  1. Open a savings account just to hold money you’ll use for estimated taxes.
  2. Divide your previous year’s tax liability by 52 and schedule weekly transfers from your checking account into this savings account. Don’t forget to make a catch up transfer if you set this up after January 1st.
  3. Use EFTPS to automatically withdraw your quarterly estimated tax payments from the savings account. The withdrawal should be 25% of your previous year’s tax liability.
  4. You’ve now met your estimated tax obligation by paying 100% of your previous year’s tax liability. (If you’re required to pay 110%, set your quarterly payments to 27.5% instead.)

If your income goes up or your deductions are lower, you’ll have a small April 15th tax bill, but you won’t have to pay a penalty.

You can learn more about how to budget for estimated taxes here.

Conclusion

If you have self-employment income, you probably need to pay estimated taxes. If you still have questions, start a chat with a tax expert.