The IRS expects certain individuals to pay federal income taxes proceed throughout the year, as opposed to one lump sum at the end of the taxable year. These interim payments are called “estimated taxes,” and the IRS offers guidance as to how to calculate and pay installments.
Who Pays Estimated Taxes?
In addition to self-employed individuals, if you have other income that isn’t subject to withholding of taxes, you may also be responsible for paying estimated taxes. Some of these examples include:
- Alimony
- Business pass-through income (e.g., if the business is set up as a limited liability company)
- Capital gains
- Dividends
- Interest income
- Prizes and awards
If you fall into the above categories or have other income that wasn’t subject to withholding, and you expect to owe more than $1,000 for the coming year, then you are responsible for paying estimated taxes.
Estimated Tax Payment Amounts
If you have a relatively predictable income stream, you will pay in four equal installments. However, if your income fluctuates throughout the year, this may lead to unequal payments.
Regarding the amounts, you may satisfy IRS requirements and avoid underpayment penalties in two ways:
- Pay 100% of your previous year’s taxes. The exception to this general rule is if your previous year’s adjusted gross income was over $150,000 ($75,000 for married taxpayers who filed separate returns), in which case the IRS expects you to pay 110% of your previous year’s taxes to avoid penalties and interest.
- Pay 90% of what you expect your current year’s estimated taxes will be. Of course, if you have fluctuating income, this may be difficult to determine, so paying 100% of your last year’s tax liability is the best way to guard against owing penalties and interest.
Payment Procedure
You make estimated tax payments throughout the year using Form 1040-ES.
Paying with your previous year’s return is a good way to get a jump on estimated taxes for the following year.
Fisherman and Farmers
The IRS has special rules for fisherman and farmers that could reduce estimated tax payments. To qualify, you must earn more than two-thirds of your gross income through commercial fishing or farming activities.
In some instances, you may decide that it’s worth foregoing the quarterly payments, and just pay a penalty, but before you make that decision, or for other guidance on figuring out taxes, call us or send a message today.