A Brief Overview of Estimated Taxes
In the U.S., the income tax system works on a "pay as you go basis". What does this mean? It means taxes are due as income is earned. For many, this is easily taken care of by having taxes withheld from their paychecks. But others have to calculate and submit estimated tax payments throughout the year.
We're going to take a deeper look at estimated taxes as well as:
- Who must pay estimated taxes
- Who does not have to pay estimated taxes
- How estimated taxes are calculated
- When estimated taxes have to be paid
What Are Estimated Taxes?
Estimated taxes are used to pay tax on income that is not subject to withholding. This includes earnings from:
- Self-employment
- Interest
- Rents
- Alimony
- Dividends
If you don't want to have taxes withheld from other taxable income sources, estimated tax payments should also be made. This other income can include unemployment compensation and any taxable part of Social Security benefits.
Who Must Pay Estimated Taxes?
Those who must pay estimated taxes include sole proprietors, partners, and S Corporation shareholders who expect to owe taxes of $1,000 or more when they file their taxes. Corporations also generally have to make estimated tax payments if they expect to owe $500 or more when they file their tax returns.
It's also important to consider legislation regarding a 0.9% Medicare surtax on wages above the combined $250,000 income threshold for joint filers and a 3.8% surtax on net investment income for individuals above the $200,000 income threshold ($250,000 for joint filers). This may impact whether or not estimated taxes are required to be paid.
Who Does Not Have to Pay Estimated Taxes?
If you receive salaries and wages, you can avoid having to pay an estimated tax by asking your employer to withhold more tax from your earnings. To do this, file a new Form W-4 with your employer. There is a special line on Form W-4 for you to enter the additional amount you want your employer to withhold.
If you receive a paycheck, the Tax Withholding Estimator will help you make sure you have the right amount of tax withheld from your paycheck.
You don’t have to pay the estimated tax for the current year if you meet all three of the following conditions.
- You had no tax liability for the prior year
- You were a U.S. citizen or resident for the whole year
- Your prior tax year covered a 12-month period
You had no tax liability for the prior year if your total tax was zero or you didn’t have to file an income tax return. For additional information on how to figure your estimated tax, refer to Publication 505, Tax Withholding and Estimated Tax.
How Are Estimated Taxes Calculated?
Individuals, including sole proprietors, partners, and S corporation shareholders, generally use Form 1040-ES, to figure estimated tax. Corporations generally use Form 1120-W, to figure estimated tax. To determine your estimated taxes, you must figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. Many people use their income, deductions, and credits from the previous year to guide them.
If you estimated your earnings too high or too low, you can use another Form 1040-ES to refigure your estimated tax for the next quarter. You want to estimate your income accurately to avoid any penalties from the IRS.
When Must Estimated Taxes Be Paid?
Estimated taxes must be paid quarterly in four equal installments on the following due dates:
- April 15
- June 15
- September 15
- January 15 of the subsequent calendar year
Checks made out to the U.S. Treasury may be mailed with an accompanying payment voucher to an IRS service center or submitted online via the Electronic Federal Tax Payment System (EFTPS) website.
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