How to Pay Estimated Tax

The self-employed must make estimated tax payments to the IRS at least four times a year

If you’re an employee who earns all of his income in wages or salary, and gets a paycheck with taxes withheld, you can stop reading right now. Tax payments are already made on your behalf and you don’t need to worry about paying estimated taxes.

But if you’re self-employed, or receive any other unorthodox income, read on. You will almost certainly need to know about estimated tax.

Estimated tax is how you pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, rents, alimony, etc. In addition, you may also need to make estimated tax payments if you do not elect to have taxes taken out of your unemployment compensation or taxable social security payments.

Do I have to file estimated tax?

To get down to the nitty-gritty, the IRS requires you to pay estimated tax if you meet both of the following conditions:

1. You expect to owe at least $1,000 in tax, after subtracting your withholding and refundable credits.

2. You expect your withholding and refundable credits to be less than the smaller of

• 90% of the tax to be shown on your 2012 return, or
• 100% of the tax shown on your 2011 return

Basically this is a fancy way of saying you need to pay estimated tax if your withholding will not be enough to cover your tax liability. Ahd if you aren’t a regular employee anywhere, it’s likely this will be the case.

Different rules apply to farmers and fishermen, household employers, and higher income taxpayers (which the IRS identifies as those with an AGI of more than $150,000). If you fall into any of these categories, consult the instructions in Form 1040-ES for the rules applying to your special circumstances.

If you also earn a salary or wage, you may be able to avoid estimated taxes entirely by increasing the withholding from your other job. This can be done by reducing the number of allowances you claim on your W-4.

How much will I owe?

In order to figure out how much to pay in estimated tax, you will need to estimate both your tax liability and withholding. If the liability is greater than the withholding, take the difference and divide it by four. This will be the general amount of each of your quarterly estimated tax payments.

Self-employed people shouldn’t forget to include self-employment tax in addition to normal income tax when calculating their tax liability. Self-employment tax includes the Social Security and Medicare taxes normally withheld from an employee’s wages.

Paying estimated taxes

Estimated taxes are due on April 15, June 15, September 15, and January 15.

You have two choices when it comes to making your estimated tax payments. The first is to snail mail Form 1040-ES [Estimated Tax for Individuals] along with your payment to the IRS the old-fashioned way.

The second is to use the Electronic Federal Tax Payment System or EFTPS. The advantage of using this system is that it’s all electronic, and you can set it up to automatically deduct tax payments on a monthly basis, making them a little easier to manage.

And don’t forget, you still need to file a normal tax return sometime before April 15th rolls around!

Photo via Global X on Flickr.

This entry was posted on Monday, September 17th, 2012 at 5:10 pm and is filed under Tax Tips and Tricks. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.