I know what you're probably thinking: "Why on Earth is this guy bringing up a discussion about taxes now? Taxes are so April!" In a way you're right -- Tax Day is in mid-April, and there are few weeks out of the year where the Internal Revenue Service sees such a dramatic influx of federal income-tax returns.
However, taxes aren't an issue you should be dealing with on a single day each year. Tax planning is actually something that should occur year-round to make your life easier when preparing your taxes, as well as save you money and hassle along the way.
Quarterly estimated taxes: Who has to pay?
One tax tactic that often has mixed reviews among taxpayers, but is something that needs to be contended with year-round, is the payment of quarterly estimated taxes. Most workers are familiar with the process of filling out Form W-4 for the IRS through their employer, thereby setting their dependent level and tax withholding per paycheck.
But a number of working Americans don't fill out a traditional W-4. For example, self-employed persons, contracted persons in various industries, and investors who receive dividend income or real estate/rental income, are just some examples of people who might receive their income upfront without a single red cent of tax being taken out. These individuals are the perfect candidates to pay quarterly estimated taxes.
According to IRS guidelines, you must make quarterly individual estimated tax payments if both of the following apply:
- You expect to owe at least $1,000 in tax for the current year tax year after subtracting your withholding and refundable credit.
- 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 (which covers 12 months).
This also means that John and Jane Q. Public who owed the IRS in the previous year are good candidates to pay quarterly taxes, too. Well-to-do workers who owe money each year, or those who simply didn't adjust their withholding on their W-4 and owed more than $1,000 in the previous year, can benefit by proactively choosing to send in quarterly estimated payments.
Quarterly taxes are typically due on April 15, June 15, September 15, and January 15, for the current calendar year.
Three reasons you should actually embrace quarterly estimated taxes
The idea of handing over money to the IRS well in advance of April's Tax Day might seem less than enjoyable, but it actually serves a purpose. If you're currently paying quarterly estimated taxes, here are three reasons to be thankful for your proactive payments.
1. No one wants a surprise come tax time
Probably the most obvious reason to pay quarterly estimated taxes is that you'll likely avoid sticker shock come tax time. If you don't pay quarterly estimated taxes, you could be left with a large and unexpected bill come April that you may not have the funds to immediately pay. And having to finance what you owe if you can't pay your federal tax bill in full will only add extra fees and interest. Paying your quarterly estimated tax provides the peace of mind that you won't be hit with an unexpectedly large tax bill in April.
2. You'll avoid unpleasant penalties
As noted above in the IRS' guidelines, if you owe more than $1,000, you could face a penalty for the underpayment of estimated tax. A good number of quarterly estimated taxpayers avoid this penalty, thankfully, but if you fail to send enough in estimated payments to the IRS, they'll tack on a penalty rate to go along with the extra money that you'll owe. No one likes penalties.
3. It gives you a better understanding of your cash flow
Finally, making quarterly estimated tax payments forces workers to take a good look at their income and cash flow. According to a 2013 Gallup poll, just less than a third of American households kept a detailed monthly budget, which tells us that most people really don't understand their cash flow. Those persons who are required to pay quarterly estimated taxes are probably more likely to have a good bead on their cash flow, or at least their income, since they need to accurately calculate how much they'll owe in federal, and potentially FICA, taxes. Anything that helps Americans gain a better understanding of their cash flow is a good thing!
Look, paying tax is never fun. But if you do have to pay quarterly estimated taxes, consider the benefits they also provide come tax time.
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