Anyone who makes money outside of a traditional job generally has concerns over the tax implications of that income.
Most people don't want to end up with a tax bill at the end of the year, or see a planned refund end up smaller than expected (or disappear entirely). But on the other hand, a lot of folks would rather not give the Internal Revenue Service (IRS) money any sooner than they have to.
In reality, for taxable income that has not had taxes withheld, the IRS has relatively simple rules. The challenge is that many taxpayers -- especially those who have typically worked traditional jobs where taxes get subtracted from their paycheck -- don't know the rules.
Unfortunately, the IRS has no "I didn't know" clause, nor is it very forgiving when people don't pay their taxes on time, even if they were unaware they had to. If you make money where taxes are not withheld, it's very important to understand under what scenarios you need to pay estimated quarterly taxes.
What are estimated quarterly taxes?
Most people associate quarterly taxes with the self-employed or small business owners. In reality, anyone who makes money that does not have taxes withheld could be required to pay quarterly estimated taxes.
"Estimated tax is a method of paying tax on income that is not subject to withholding tax. This can include income from self-employment, business earnings, interest, rent, dividends and other sources," according to the IRS. These taxes are generally paid quarterly in four equal installments (though they don't have to be equal if your income picture changes).
Pay too little on your estimated taxes, and you will owe money when you file your tax returns (potentially along with penalties). Pay too much, and you get the money back in the same way you would with normal withholding.
Who has to pay estimated taxes?
The IRS requires you to make estimated tax payments during the current tax year if both situations listed below apply:
- You expect to owe at least $1,000 in tax for the current tax year after subtracting your withholding and refundable credits.
- You expect your withholding and refundable credits to be less than the smaller of:
- 90% of the tax to be shown on your current year's tax return, or
- 100% of the tax shown on your prior year's tax return. (Your prior year tax return must cover all 12 months.)
The self-employed and sole-proprietor business owners almost always have to pay estimated quarterly taxes (unless their business loses money). In addition, people who are partners in a business, a corporation, or an S Corporation often pay quarterly taxes if they expect to have at least $500 in tax liability. In addition, even people who work regular jobs where taxes are withheld are supposed to pay quarterly estimated taxes if they owed money to the IRS when they filed their previous year's taxes (in reality, many people in that situation simply adjust their withholding to have more money take out in each paycheck).
Better safe than sorry
The IRS has a form, IRS Form 1040-ES (Estimated Tax For Individuals) which you can use to calculate your estimated tax payments. Coming up with the number works roughly in the same way you figure your annual tax liability. You'll need to know your income, deductions (expenses can be significant for small business owners), credits, and paid taxes.
Once you've figured out the number, you can pay the IRS a number of ways. These include IRS Direct Pay, which takes the money right out of a checking or savings account, IRS Pay By Card, where you use a credit or debit card, or via phone through one of two methods WorldPay US, Inc. (1-844-729-8298) or Official Payments (1-888-872-9829). Payments for each respective quarter are due April 15, June 16, September 15, and January 15 (of the following year).
If you meet the criteria above, it's important to not only pay, but make a good effort at getting the amount right. Failure to do so and underpaying your estimated taxes, in some cases, results in a penalty. "The penalty is imposed on each underpayment for the number of days it remains unpaid," according to the IRS. To make matters worse, you could even pay a penalty if you're owed a refund, if your estimated payments weren't high enough but you caught up when you filed your annual return.
In a very broad sense, the IRS tends to not punish people who make good faith estimates. Get things a little wrong, but within a reasonable amount, and you likely won't be hit with a penalty. Underpay willfully or due to obvious carelessness, and you're likely going to hear from the tax man.