When someone is an employee (of a small business, of a corporation…the list goes on), their employers withhold taxes from every paycheck that they are owed. This money is sent to the IRS and to your state government to account for the employee’s income taxes.
But what about people who are self-employed? What if somebody just has additional income outside of their salary?
When this is the case, a person needs to pay estimated taxes. These payments are made on a quarterly basis.
Almost everyone who earns income is subject to income tax– federal income tax, state income tax, Social Security tax, etc. According to the IRS, a person’s tax liability needs to be paid before the actual tax due date. This happens automatically if you work a typical job and your income from your employer is subject to federal withholding
When withholding isn’t an option, people need to make their tax payments on their own.
Some examples of income not subject to withholding (otherwise known as income that you still owe taxes on after you receive it) include:
- Business earnings
- Taxable alimony
- Gains from stock sales or the sale of other assets
What Are Estimated Taxes?
Lots of people earn income that is not subject to federal tax withholding during the course of the year.
This income is still subject to tax. Just like any other working American, the IRS wants contractors and other earners to pay taxes as they earn their money. Most people get taxes deducted out of their paychecks. If you earn money independently of an employer, this is not the case.
Taxpayers who earn income like this are required to pay estimated taxes on a quarterly basis.
How Do I Know If I Need to Pay Estimated Taxes?
You need to pay estimated taxes if:
- You owe more than $1,000 in taxes after calculating your withholding and federal credits for the year
- Your federal income tax withholding plus your estimated taxes paid on-time do not amount to at least 90% of the total tax you’ll owe for the tax year
Paying Your Estimated Taxes
The best way to pay estimated tax is in four equal payments (made to the IRS) over the course of a year. If your business is seasonal, though, it’s no big deal– the IRS is more than aware that lots of jobs only pull in an income for certain periods.
Here’s a standard rule of thumb to abide by: pay your estimated tax as you get your income.
This looks different for different people. If your work is very seasonal, you may want to look into the option of an annualized income installment method. This allows individuals to send in estimated taxes once a year. You can find more information about the annualized income installment method in IRS Publication 505 and Form 2210.
The IRS accepts estimated tax payments in several ways. The full instructions for making a payment can be found on the IRS website. You can choose from:
- Direct pay from a checking or savings account
- The IRS2Go mobile app
- Payment with a debit or credit card
- Same-day wire through your band
- Cash (through participating retail establishments)
- The Electronic Federal Tax Payment System
Payments made by check or money order should include a Form 1040-ES voucher.
Other Reasons Your Quarterly Payments Might Not Be Equal
We get a lot of questions from people who are wondering why their projected quarterly payments seem to be so large. The best way to get help with your finances is to schedule to consultation with a tax law professional, but we can offer some common reasons why people end up with unequal payment amounts:
- The previous year’s tax overpayment was credited to the current year’s estimated payments
- You failed to calculate your estimated payments until after April 15 (July 15 in 2020), which is when the first payment is due
- You unexpectedly made a lot of money in one specific quarter
Why Is It Best to Pay Estimated Taxes in Advance?
Tax professionals advise that estimated taxes be paid in advance.
- If you don’t pay your taxes at all, you might end up owing the IRS an underpayment penalty
- You’ll still need to pay the taxes that you owe, too
How to Calculate Estimated Taxes
Americans can use Form 1040-ES to help them calculate their taxes. This form, produced by the IRS, offers lots of background information and instructions to help individuals find out which steps they should take next (based on employment, income, etc.).
The form also includes vouchers. These vouchers can be sent with your estimated tax amounts if you make payments by check or with a money order.
The actual calculation process is math-heavy and relies on lots of specifics. Usually, that means that:
- Your tax accountant will perform the calculation for you OR
- You can input information into tax preparation software and wait for the calculation
There are some simple– but important– things to keep in mind when it comes time to calculate estimated taxes:
- If you’re applying your previous year’s tax refund to the present year’s taxes, don’t forget to note it
- Check the income claimed and education taken on the year prior’s tax return; see whether it will be comparable in 2020 (this helps make obvious mistakes more obvious!)
Exceptions: Fishermen and Farmers
If you are a fisherman or farmer, estimated taxes work differently. These individuals need to meet certain criteria, but sometimes pay less in estimated taxes than other self-employed people.
- Qualified farmers and fisherman earn over 2/3 of their taxable gross income from farming or commercial fishing
Silver Tax Group Can Help Calculate Estimated Taxes
Lots of people don’t want to deal with calculating their own estimated taxes– fortunately, we’re here to help!
At Silver Tax Group, our team of tax attorneys works diligently to help clients avoid costly penalties and keep their finances in check. If you or somebody you love is a contract worker without questions about estimated taxes, get in touch with us today! Readers can schedule a complimentary consultation to speak to a tax professional as soon as possible.