In a normal year, your first quarter estimated tax payment, your tax return or your tax return extension and payment would all be due on April 15th and your second quarter estimated tax payment would be due on June 15th. This is not a normal year. This year all of the above are due July 15th. So, how much should you pay in estimated taxes? Do you even need to pay estimated taxes?
As employees, the employer takes out a portion of your paycheck as taxes and remits it to the government. When you are self-employed, you may have higher take home pay than your employee friends. That said, the government still wants their share of your earnings. They want it at least quarterly. At the end of each “quarter”, the IRS requires you to pay the tax on the business profits as well as any self-employment taxes that might be owed.
If you expect to owe at least $1,000 in federal taxes for the year, you will be required to make estimated tax payments if you are an employee, sole proprietor, partner in a partnership, S-Corp shareholder, or member of a limited liability company or pay a penalty for failing to pay them. If you had no tax liability last year (paid no taxes), you do not need to make estimated tax payments this year but you may if you choose to. Making or not making estimated tax payments does not mean you will not owe taxes at the end of the year.
The IRS wants you to pay the smaller of at least 90% of the tax due for the current year or 100% of the prior year (110% if prior year income was more than $125,000) to avoid penalties. The easiest way is to pay the 100% or 110% of last year rather than having to calculate your current income each quarter under the annualized income installment method.
Estimated taxes should be paid on April 15th for the first quarter (January/February/March); June 15th for the second quarter (April/May); September 15th (June/July/August), and January 15th of the following year for fourth quarter (September/October/November/December). This year, 2020, the first two payments are due on July 15th. You can pay by check, electronic funds transfer or by credit card (subject to additional fees). You send these payments on a Form 1040-ES.
States may also require estimated tax payments.
Using the safe harbor calculation (no penalty assessed) amounts above may leave you over or under paid for tax due on the current year taxable income. Most people are okay with the refund resulting from an overpayment but are less happy about owing when they go to file their return. If you want to double check your numbers, you can use an annualized income method to calculate the tax.
To start, you would figure out your year-to-date income/profit and use 15.6% for payroll taxes and the tax rate your income will fall in at year end. The United States of America uses a tiered progressive tax model, meaning the higher your taxable income, the higher your tax rate will be but to promote fairness, everyone pays the same rates on the same income amount (i.e. someone who has taxable income of $50,000 and another with taxable income of $500,000 will pay the same amount of tax on that first $50,000). Because of this, you will have a tax bracket, or the rate where your last taxed dollar falls into, and an effective tax rate, or the blend of the rates as you move up the income scale, which will generally be lower. The tax brackets range from 0% to 37%. (Visit IRS.gov and search for “tax rates” to see the current year rates). The married filing joint income brackets are twice the single filer until the 35% bracket. Multiplying the estimated taxable income by the estimated tax rate and adding any self-employment tax to it will give you an estimate of what will be due.
To avoid the penalty, make at least the safe harbor (100% or 110% of prior year tax) as estimated tax payments, unless your income will be significantly lower in the current year. If your income will be higher in the current year, you can calculate the tax on the increase from prior year and add it to your estimates if your want to owe less at tax filing time.
As always, you can also reach out to your CPA to have them help you calculate both the safe harbor amounts or annual income installments.
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