Update to below: the IRS extended the tax payment deadline due to COVID-19 (coronavirus). With the change, 2019 tax year payments and Q1 estimated tax payments are now due by July 15, 2020. Many state tax deadline extensions have also been announced, with more to come.
I get enough questions from readers asking me to explain estimated tax payments that it makes me wonder if people actually avoid earning self-employment or side income simply because they are intimidated by the tax implications.
When you have an employer, tax payments are fairly straight forward. Through your payroll, taxes are automatically deducted and sent to the IRS, state, and local (if applicable) authorities. At the end of the year, when you complete your tax return, you find out if you have paid too much (you get a refund) or too little (you must pay the balance). And based on that, you can then change your tax withholding on your W-4 to withhold more or less taxes on each paycheck.
Estimated tax payments for self-employment income (aka “side income”) is new territory for those who have always had payroll done for them through their employer. It’s not necessarily more difficult, but it’s definitely different. Having made estimated payments for income earned through this blog over the years, I have learned enough of the basics to at least point you in the right direction and hopefully remove some of those fears and hesitations that might be holding you back from pursuing entrepreneurial activities.
What are Estimated Tax Payments?
To put it most simply, estimated tax payments are a means to pay taxes due on income that is not subject to withholding taxes over the course of the calendar year. Estimated payments (like all income tax payments) are pay-as-you-go over the year, but you are the one doing the withholding in the place of an employer. You’ve earned the money and you are expected to pay the taxes on your own through estimated tax payments.
Depending on your state and whether or not there is a state income tax, you may be responsible for paying not only federal estimated tax payments, but state estimated tax payments as well.
Who is Required to Make Estimated Tax Payments?
Estimated payments are typically required for self-employment, business, side income earning projects, dividends, interest, landlord rent, prizes, awards, alimony, or other non-withheld sources.
In general, if you earn income that results in taxes due that exceed $1,000 for the tax year, you must make estimated tax payments. More specifically, according to the IRS, you should make estimated tax payments if:
- You expect to owe at least $1,000 in tax, after subtracting your withholding and refundable credits.
- You expect your withholding and refundable credits to be less than the smaller of 90% of the tax to be shown on your current year’s tax return, or 100% of the tax shown on your previous year’s tax return.
State estimated tax rules may vary.
It’s worth noting that even if your income level falls below the standard minimum income to file taxes thresholds, if you have self-employment income, you need to file a tax return if net self-employment income is $400 or more (gross).
When do you Make Estimated Tax Payments?
|Time Period:||Estimated Tax Payment Date:|
|January 1 - March 31||April 15, same year|
|April 1 - May 31||June 15, same year|
|June 1 - August 31||September 15, same year|
|September 1 - December 31||January 15, subsequent year|
As with your 1040 tax return, the tax deadline is really the date that your mail to the IRS must be postmarked or paid if you are using a non-check method.
If a deadline falls on a holiday or weekend, it is pushed to the next business day.
How do you Calculate Estimated Tax Payments?
To get a rough worst-case idea of how much you will owe, simply take your quarterly income and multiply it by the tax bracket rates it falls into. If income from a day job tops out in the 35% bracket, for example, your additional income starts from there.
If your income is pretty consistent, you will pay approximately one-fourth of your total estimated tax due for the year during each of the four estimated tax payment deadlines. If your income varies significantly from one quarterly period to another, then your payment should be adjusted appropriately.
However, rough is not good enough. You have a little leeway, but you should crunch some numbers to get more specific so you don’t end up with a big penalty. If you’re not sure how much your estimated payments should be, your tax brackets, deductions, tax credits, and more all come in to play in the calculation. Self-employment taxes, net investment income tax, and additional medicare tax could all play into your calculation as well. The best thing to do would be to fill out the 1040-ES worksheet.
How do you Make Estimated Tax Payments?
There are a number of ways to make estimated tax payments. The two easiest, in my opinion, are:
- Pay your taxes online with IRS Direct Pay. This is a free ACH transfer direct from your bank account.
- Pay by check and submit it with a 1040-ES estimated payment voucher that you print out when completing your previous year’s tax return.
You can also pay your taxes online by credit/debit card (which requires you to go through a third party and pay a convenience fee) or by phone.
How Can you Avoid Getting Penalized for Underpayment of Estimated Taxes?
In short, yes. If you did not pay enough in estimated payments to cover your tax obligation, you may have to pay a penalty for underpayment of estimated tax. This penalty can be avoided if you owe less than $1,000 in tax after subtracting withholdings and credits, or if you paid at least 90% of the tax due for the current year, or 100% of the tax shown on your return for the prior year, whichever is smaller. So there is some leniency and you don’t have to pinpoint your payments down to the exact dollar amount.
Check out IRS form 2210 for more info on underpayment penalties.
Can you File an Extension for Estimated Payments?
Many taxpayers are aware that you can file an IRS tax extension that will give you an extra 6 months to file your return. Can you do the same for estimated payments? Nope! The IRS tax extension is for filing, not for payments. Payments are still due at the tax deadline. The same is true of estimated payments. No extensions.
What Else do I Need to Know About Estimated Tax Payments?
I’m sure I will have neglected to mention something, but here are a few more key points:
- You are not required to fill out tax forms as you do for your tax return. Just submit payment.
- Keep track of the deadline dates by adding them to your calendar, so you are not late in sending payment. They are easy to forget about!
- When you file your 1040, you factor in all earnings, taxes withheld, etc. Any estimated payments made during the year are subtracted from your total tax obligation.
- There are ways to actually pay your taxes with a credit card and profit. With estimated tax payments, there are abundant opportunities to do so (if you do it wisely).
Check out IRS Publication 505 for more information on estimated tax payments.
Also, check out the IRS’s sharing economy tax guide for more tips.