For many people, the tax deadline comes once a year.
Everyone knows that individual tax returns need to be filed by the middle of April.
If you owe money to the government (federal and state), you need to make those payments by the tax filing deadline.
What many taxpayers don't realize, though, is that they are actually paying taxes quarterly.
Their employers deduct taxes from their paychecks on a monthly basis. Quarterly, those employers then pay taxes. It's unnoticeable to most people who have traditional jobs because the money is deducted automatically.
Those of us who are self-employed, or own own businesses, are very aware that estimated tax payments need to be made quarterly.
Paying Quarterly Estimated Taxes
Starting your own business can have tax benefits. However, you do need to keep on top of your quarterly payments. First of all, if you owe more than the IRS thinks you should at the end of the year, you will be assessed a penalty. This penalty can be fairly harsh in some cases. This means that you shouldn't just hoard your money in a high yield savings account all year and then write a big check to the IRS at tax time.
Instead, you are expected to make quarterly payments, estimated based on what you earned the previous year. The easiest way to estimate your quarterly taxes is to take the total amount you owed the previous year, and divide it by four. So, if your total tax bill (before you account for estimated payments you made to the government) was $10,000, you will need to pay $2,500 each quarter. As long as you pay 100% of what you owed the previous year, you are largely protected from penalties later on.
There is a more complex method of figuring out what you owe by looking at your income tax, AGI, and your self-employment tax rate, then multiplying that by your quarterly profit every three months. I find it's easier just to base my quarterly payments on what I owed the previous year.
Planning to Pay Your Quarterly Estimated Tax Bill
Planning ahead can make the payment of your quarterly estimated taxes a little easier. I like to divide what I owe by 12. Then, each month I place that amount in a high yield savings account. When quarterly taxes are due (April 15, June 15, September 15, and January 15), I transfer the amount I owe out of the account and into a checking account. This allows me to earn some interest, while still making sure that I have what I need to pay my quarterly taxes.
If you are late paying taxes, realize that you will have to pay interest. The IRS charges interest immediately, based on the postmark on your payment.
And, don't forget about your state taxes. Some states don't require quarterly payments, so it's easy to forget about it — until you are overwhelmed by the tax bill later. This happened to me once. It isn't pleasant. Even if your state doesn't require quarterly payments, estimate what you would owe, and then set money aside each month, or each quarter, so that you are prepared come April.
If you are self-employed, it can be a good idea to make quarterly estimated tax payments.
Making regular tax payments can help you avoid paying interest penalties, and it can shield you from the hardships associated with a large tax bill once a year.
Others who should consider making quarterly estimated tax payments include investors and landlords whose tax withholding from a regular job may not be enough to cover the full amount of your tax bill.
You will need to make quarterly tax payments as follows: April 15, June 15, September 15, January 15.
Figuring Your Quarterly Tax Payments
When you make quarterly tax payments, you are estimating your tax liability. It is important to be as accurate as possible. While you are unlikely to exactly figure your taxes, you should try to come as close as possible. Here is how you can estimate how much to pay each quarter in taxes.
- Use your most recent tax return to figure your tax liability. The easiest way to do this is to subtract your total from line 63 (your withholding) on Form 1040 from line 62 (your total tax). This will give you an idea of how much you are usually short.
- Divide the result of your subtraction by four. This will provide you with the amount of money you need to pay every three months in order to meet your tax requirements.
- If you think that you will see a big difference in income (more or less) you can estimate your expected total income for the year, and divide that by four. Just realize that if you owe a great deal at tax time, you may be charged penalties and interest.
- For those that are self-employed, you will need to estimate regular income tax and self-employment tax. First, figure your average tax rate by dividing your income tax, found on line 43 of Form 1040, by your AGI (see line 37). Add your average tax rate to 15.3%, which is the self-employment tax rate. You should have a percentage as an answer. Multiply this percentage by your quarterly profit to decide how much to pay.
- An alternate method of figuring your liability for self-employment is to take your tax requirement from the year before, and divide it by four. This is much easier than figuring your required estimated tax payments each quarter. As long as you pay 100% of the tax shown on the most recent tax return, you should be largely protected from penalties and charges down the road.
Making Those Tax Payments On Time
Once you figure how much you owe in quarterly estimated taxes, it becomes important to actually make your payments. If you decide to mail in your payment, it needs to be postmarked by the appropriate due date. Your payment should be accompanied by Form 1040-ES. Write your Social Security Number or your Employer Identification Number in the memo line of your check, just in case. Your check should be made out to the United States Treasury.
Making quarterly payments easy
You can also use the Electronic Federal Tax Payment System (EFTPS) to make your quarterly estimated tax payments. You can go in every quarter and make your payment, or you can set up recurring payments that are automatically deducted from your checking account, or that are automatically charged to your credit card.
With EFTPS, you can also break down your estimated taxes into monthly payments, and set up automatic monthly payments as part of your budget. This system also allows you to print out reports.
Bottom line: If you want to avoid penalties, it is a good idea to make regular estimated tax payments if you have income beyond a regular job with an employer who withholds your income taxes. You can figure your requirement on your own, or with help from a financial or tax professional, and you can easily make regular payments to the Treasury.