Primarily, estimated taxes are a way of paying tax on income that has been earned but does not have anything withheld on it. These taxes are paid quarterly to the Internal Revenue Service (IRS) by anyone whose income is not subject to withholding taxes. When people earn income through interest, wages, dividends, or rent, they have to pay tax for it.
Regular employees have their taxes deducted from their paychecks automatically by their employer and sent to the IRS. However, business owners and those who are self-employed have to estimate how much tax they owe and remit it themselves.
Why should you pay estimated taxes?
If you have income that does not have taxes withheld, it is in your best interest that you pay estimated taxes. Paying the estimates helps you avoid underpayment penalties, late filing fees, and panic as you rush to pay the year’s taxes before the April 15th deadline. Late filings and underpayments can quickly add up considering you typically have to pay at local, state, and federal levels. To avoid the punitive charges—calculate your estimated taxes carefully, and keep your payments on schedule.
When are estimated taxes due?
Estimated tax payments are due four times a year. The important dates you should note are April 15th, June 15th, September 15th, and January 15th. How do you know the amount you owe? You can use the current year method, the prior year method, or the annualization method.
When considering the current year method, you need to project this year’s income and come up with calculations to pay at least 90 percent of the tax you should owe.
To use the prior year method, simply take the amount you paid in taxes the previous year, subtract any withholding paid, and divide by four to get your quarterly payments. Please note, as always, there are certain alternatives and exceptions to this general formula as your income exceeds certain levels, but this is a good starting point for calculating on your own.
If you receive your income irregularly over the year, for example, year-end dividend payments, use the annualization method to remit applicable taxes. Please keep in mind that with the annualization method, you will need to file Form 2210 with your tax return to explain why you did not split your payments evenly throughout the year.
When you pay your estimated taxes, you reduce your overall liability. The more estimated taxes you pay over the year, the less you will be required to pay during tax season. Have any questions or need to know where to locate your estimated tax payment vouchers? Contact us today!