If you are self-employed, or have other sources of income in addition to a salary or wages, such as dividends, interest, capital gains, rents and royalties, you may have to make estimated federal income tax payments during the year. Estimated tax payments are required when your withholding tax is not sufficient to cover your tax liability. Payments are made based on your estimated tax liability for the year, less your withholding taxes. There are four periods for reporting and paying estimated tax. When you file your income tax return at the end of the year, these estimated tax payments, plus any income tax withheld, are credited against your tax liability based on your actual income for the year, to determine whether you are due a refund or owe additional tax.
What are Estimated Federal Income Tax Payments?
U.S. federal income tax is a pay-as-you-go tax, and must be paid during the year either through withholding or estimated tax payments. If your withholding tax is not sufficient to cover your tax liability, or if you have sources of taxable income that are not subject to withholding, you may have to make estimated tax payments.
If you do not pay enough tax during the year, either through withholding or estimated tax payments, you may be subject to an underpayment penalty when you file your income tax return. Estimated tax payments are made in four periods during the year, and each period has a specific payment due date. If you do not pay enough tax by the due date for each of the payment periods, you may be charged a penalty for that period, even though you have paid enough tax to cover your total tax liability for the year and are due a refund when you file your return.
Who Is Subject to Estimated Payments?
In general, you do not have to make estimated tax payments if you expect that your Form 1040 or 1040A for this year will show a tax refund or a tax balance due of less than $1,000.
Tax Withholding and Estimated Tax Payments
If all your taxable income is subject to withholding, and enough tax is being withheld, you will probably not need to make estimated tax payments. If you did not have a tax liability last year, and you do not have any significant changes in the level or source of your income in the current year, your withholding will probably be sufficient to cover your tax liability this year. But if you have a significant increase in your income, or you begin to receive income from sources that are not subject to income tax withholding, you may need to make estimated payments.
Self-Employed
If you are in business for yourself, you will not have income tax withheld from your earnings, and you are responsible for estimating your tax liability and making estimated tax payments. For self-employed taxpayers, the estimated payments include both federal income tax and self-employment tax (equivalent of social security and Medicare) on your earnings.
Tip Income
If you receive $20 or more a month in tips on your job, you must report the total amount of tips you receive to your employer, so that social security, Medicare, and federal income tax can be withheld. If the amount of your regular pay is not enough to cover these withholding taxes, you can give your employer money to make up for the shortage. If you do not report your tips, or you do not cover the shortage in your withholding, you may have to make estimated tax payments.
Household Worker
If you are a household worker, tax is withheld from your pay only if you ask your employer to withhold it, and your employer agrees. If tax is not withheld, you will need to make estimated tax payments.
Sick Pay
If you receive sick pay from a third party, such as an insurance company, you must ask to have income tax withheld, by completing Form W-4S. If you do not, you may need to pay estimated tax on your sick pay.
General Rule
The general rule is that you must make estimated tax payments:
If you expect to owe at least $1,000 after subtracting your withholding and credits when you file your return for this year, and
You expect your withholding and credit for this year to be less than the smaller of::
90% of the tax you expect to report when you file your return this year, or
100% of the tax shown on your return from last year
If your main source of income is your salary or wages, and you see that not enough tax is being withheld, you may want to give your employer a revised W-4 Form.
Married Taxpayers
If you are married, you and your spouse can make joint estimated tax payments. Making joint estimated payments does not affect your choice on how you want to file your return at the end of the year. You can still file either as married filing jointly, or married filing separately.
If you plan to file a joint return this year, but filed separate returns last year, for purposes of the general rule on estimated payments, your tax for last year is the total of the tax reported on your separate returns from last year, whether you filed as single, head of household, or married filing separately.
If you plan to file separately this year, but filed jointly last year, each spouse would consider his or her share of the total joint tax from last year. To distribute the joint tax from last year, you would each calculate how much your tax would have been if you had filed separate returns last year, based on the separate filing status you plan to use this year. You would then add these two amounts together to determine how much total tax you would have paid if you had both filed separately last year. Each spouse would then calculate his or her proportionate share, and this would be the amount of tax from last year for purposes of the general rule for paying estimated tax this year.
Special Rules
For taxpayers who receive at least two-thirds of their income from farming or fishing, the general rule of 90% of the expected tax for this year is replaced by 66 2/3%. For higher income taxpayers, whose adjusted gross income from last year was over a certain amount (published by the Internal Revenue Service (IRS) each year in Publication 505, Tax Withholding and Estimated Tax), the 100% of last year’s tax requirement is replaced with 110%.
Estimating Your Current Year Income and Tax
The amount of estimated tax you need to pay will depend on your estimated taxable income for the year. You may be able to use the tax return you filed last year as a starting point. You can them make the necessary changes to the figures, based on changes in your personal situation and income for the current year, as well as changes in the tax law. Some of the aspects you should consider include:
Any change in your filing status
Changes in your number of dependents
Changes in the level of your income as compared to last year
New sources of income
Deductions and credits you may be able to take this year
IRS Publication 505 and Form 1040-ES
Some amounts in the tax law generally change each year, such as the amount for personal exemptions and dependents, and the standard deduction. IRS Publication 505, Tax Withholding and Estimated Tax, includes a section on important changes to be noted each year. These are also included in the package for Form 1040-ES, Estimated Tax for Individuals. Both of these publications also include a worksheet to help go through the calculation to estimate your current year taxable income, and current year tax rate schedule to determine the resulting tax. Form 1040-ES and Publication 505 are available on the IRS website.
Adjusted Gross Income
The worksheet starts with your expected adjusted gross income for this year. For purposes of this worksheet, you should include all your taxable income in this amount, including income that is subject to withholding tax. This is necessary in order to calculate the correct amount of estimated tax for the year. There is a separate line below in the worksheet to show estimated withholding tax.
If You Receive Social Security Benefits or are Self-Employed
There is a separate worksheet in Publication 505 to help you estimate your adjusted gross income if you expect to receive social security benefits, and another worksheet to estimate your earnings from self-employment, the self-employment tax, and your adjustment to income for one-half of your self-employment tax.
Standard Deduction or Itemized Deductions and Exemptions
Once you estimate your adjusted gross income, you reduce this by the standard deduction amount applicable for the year, or your estimated itemized deductions. There is another worksheet in Publication 505 to determine any limitation that may apply on your itemized deductions, based on the level of your adjusted gross income. Then you would determine your personal and dependent exemptions for the year to arrive at your taxable income.
Tax
Based on your taxable income, you can determine your estimated tax by using the tax rate schedules in the Form 1040-ES package or in Publication 505. If you expect to have a net capital gain, or qualified dividend income, the tax rate schedules do not apply, and you will need to use the separate worksheet in Publication 505 to figure your tax. Also, if you are subject to the alternative minimum tax you will have to make a separate calculation on Form 6251 and add this amount to your estimated tax.
Credits
From your total estimated tax amount, you would subtract any special credits for which you may be eligible, and then, if you are self-employed, you would add your expected self-employment tax (calculated using the worksheet mentioned above, if you choose), and would also add any other special taxes you may owe, such as taxes on early distributions from IRA or annuity plans. Finally, you would subtract your expected earned income credit, additional child tax credit, and any other applicable credits, to arrive at your total estimated tax.
Required Annual Payment
The following lines on the worksheet apply the general rule of 90% of your current year estimated tax (with the exceptions for farming and fishing income (66 2/3%), and higher income taxpayers (110%)), and 100% of last year’s tax. The result of these calculations will show the “required annual payment to avoid a penalty”. From this amount, you subtract the estimated amount of tax that will be withheld, and the difference, if any, is the amount you will have to cover with estimated tax payments.
When are Estimated Tax Payments Due?
The year is divided up into four periods for estimated tax payment purposes, with a specific due date for each period, as follows:
April 15th, for the period January 1 through March 31
June 15th, for the period April 1 through May 31
September 15th, for the period June 1 through August 31
January 15th of next year, for the period September 1 through December 31
If you file your annual income tax return and pay the tax you owe by January 31st, you do not need to make the final estimated payment due on January 15th.
For fiscal year taxpayers, the due dates would be:
15th of the fourth month of the fiscal year
15th of the sixth month of the fiscal year
15th of the ninth month of the fiscal year
15th of the first month following the end of the fiscal year
When to Start Making Estimated Tax Payments
You start making estimated tax payments when you have income that is subject to estimated tax. This may require you to revise your estimate at different times during the year, as your personal situation and your income changes.
If you have income in the first period that is subject to estimated tax, you must make your first estimated payment by the due date for that period (April 15th). You can pay all your estimated tax at that time, or you can pay it in installments, on each of the pay period due dates.
If you do not have income subject to estimated tax until a later period, here again, you could pay all your estimated tax on the due date for the first period in which you have income subject to estimated tax, or you can pay it in installments over the remaining periods.
There is an exception for farmers and fishermen. If two-thirds of your income is from farming or fishing, you only have to make one estimated payment – the final one, due on January 15th of next year. The other three period due dates do not apply. And, if you file your return and pay any tax you owe by March 1st of the following year, you do not have to make any estimated payments.
How To Figure the Amount of Each Payment
If your income is relatively level throughout the year, you should probably use what the IRS refers to as the Regular Installment Method. If you have significant fluctuations in your income, you may need to use the Annualized Income Installment Method.
Regular Installment Method
Under this method, you basically take your estimated required annual tax payment, divide it by four, and pay the amount due each period. If you have to refigure your estimated tax after you make your first payment, because of changes in your personal situation that could result in changes to the amounts you estimated for income, adjustments to income, deductions, exemptions or credits, and these changes result in more tax, you can pay the entire additional amount by the due date for the next period, or you can spread the difference over the remaining periods.
Annualized Income Installment Method
If your income is not evenly distributed throughout the year, and there are certain periods in which your income is higher, you may need to use the annualized method. There is a worksheet in Publication 505 that you can use to determine your estimated tax payments by period. If you are self-employed, there is a separate worksheet for annualizing your estimated self-employment tax.
To complete the worksheet, you will need to have a reasonable estimate of your income and deductions by period, showing the accumulated amounts as they build up from the beginning of the year through the end of each period. This worksheet will then annualize your taxable income and will show you the amount of the estimated tax payment you need to make each period. If you use this annualized method, you will need to file Form 2210 with your annual income tax return.
How Are Estimated Tax Payments Made?
There are five ways you can make estimated tax payments:
You can credit any overpayment from last year’s return to this year’s estimated taxes. You do this by indicating on the return that you filed for last year that you want the overpayment credited to this year’s taxes, instead of receiving a refund. The credit is then applied to your estimated payments this year in the order necessary in order to avoid an underpayment penalty.
You can use the payment vouchers from Form 1040-ES (available on the IRS website) and send your estimated tax payments by mail.
You can use the Electronic Federal Tax Payment System (EFTPS) and make your payments either online or by telephone.
When you file your return for last year by Internet, you can authorize and schedule electronic funds withdrawals from your bank account for your estimated tax payments for this year.
You can make payments by credit card, using one of the service providers indicated in the Form 1040-ES instructions or in Publication 505.
How Are Estimated Payments Reported on the Tax Return?
Estimated tax payments are reported in the Payments section of Form 1040 or 1040A when you file your annual tax return. You should include any overpayment from the prior year that you applied to the current year estimated tax.
Married Taxpayers
If you and your spouse paid joint estimated tax but are now filing separate income tax returns, you can divide the amount paid in any way you choose as long as you both agree.
If you cannot agree, you must divide the payments in proportion to each spouse's individual tax as shown on your separate returns for the current year. If you or your spouse paid separate estimated tax but you are now filing a joint return, add the amounts you each paid.
Divorced Taxpayers
If you get divorced in the current year and you made joint estimated tax payments with your former spouse, either spouse can claim all or part of the joint payments. If you cannot agree, you must divide the joint payments in proportion to each spouse’s individual tax as reported on your separate returns for this year.
If you are claiming a portion of a joint payment on your separate return, you should put your former spouse's social security number in the space provided on the front of Form 1040 or 1040A. If you were divorced and remarried in the current year, you should put your present spouse's social security number in the space provided on the front of Form 1040 or 1040A, and then in the Payments section, to the left of the estimated tax payments line, you should write your former spouse's social security number, followed by "DIV".
Underpayment Penalty
Even if you fail to make estimated tax payments, you will not be liable for any underpayment penalty provided that any one of the following applies:
The total amount of tax withheld and estimated tax payments is at least 100% of your tax for last year (110% for higher income taxpayers with adjusted gross income over a certain amount),
The balance of tax you owe according to your return is not more than 10% of your total tax for the year, and you made all your estimated tax payments on time,
The total amount of tax reported on your annual return, minus the amount of income tax withheld, is less than $1,000,
You did not have a tax liability last year, or
You did not have any tax withholding, and your current year tax liability (excluding any household employment taxes you owe) is less than $1,000.
There are special rules for farmers and fishermen, as noted above.
If the above exceptions do not apply, you could be subject to an underpayment penalty. And, as mentioned above, it is possible that you could be subject to an underpayment penalty for a certain period, even though you paid sufficient estimated taxes for the whole year. In most cases the IRS will calculate the penalty for you. You will only need to file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, in the following situations:
You are requesting a waiver of part of the penalty.
You use the annualized income installment method to pay estimated taxes.
You treat federal income tax withholding as paid on the date it was withheld.