As you know, I have been self-employed for quite some time now. Most of my self-employment income doesn’t have any taxes withheld and is reported on a 1099. That means I have to make quarterly estimated tax payments.
There can be a lot of confusion about how to handle such estimated tax payments. Coincidentally, I just received a related tax question from a reader:
My wife has a full-time job in which taxes are withheld from her paycheck as typical with an employee/employer situation. She also has a part time job in which no taxes are withheld since she is considered an independent contractor. Is she required to pay those taxes quarterly or can we wait to file our regular return and calculate whether any additional tax liability exists? We itemize and regularly get large returns.
The short answer is yes, you should calculate and make the payments to be safe. But you may be exempt based on the amount you earn, the amount you have withheld on your W-2s, and/or the amount you paid in taxes last year. I did some research on this topic as a whole and here’s what I came up with:
Federal Tax Withholding and Estimated Tax Payments
Here in the US, taxes are paid as you earn or receive the income. If you are employed, your employer is required to withhold these taxes from your periodic pay checks. It’s up to you to tell your employer the correct amount to withhold based on your filing status and dependents. This is why you complete a W-4 when you are hired. If you are self-employed, or earn income through some other source (e.g. rental income, capital gains) where taxes aren’t withheld, then you need to make estimated tax payments on a quarterly basis.
The payments can be made using a check with Form 1040-ES, electronically using the Electronic Federal Tax Payment System, or over the phone with a credit or debit card. Or you can apply a refund from the previous tax year.
The payments need to be made generally on the following dates:
- April 15
- June 15
- September 15
- January 15 (of the next year)
If those dates fall on a weekend or holiday, your quarterly tax payment needs to be made by the next business day.
Calculate Estimated Quarterly Tax Payment
To calculate how much you need to pay in estimated taxes, do the following:
Take your income minus expenses for the period and multiply that times your marginal tax rate (taxes paid in prior year divided by taxable income).
Note: If you are self-employed and have to pay self-employment tax on this income, then add 15.3% to that marginal tax rate percentage before multiplying it by the income.
Estimated Tax Penalty
If you don’t make these estimated payments each quarter, then there is a chance you will face a penalty, called the penalty for underpayment of estimated tax. I say a chance because certain tax filers are exempt from this penalty. I’m not going to get into the particulars of this calculation because it’s insanely hairy depending on your details. I will say that the penalty is generally figured at the annual rate of 4% for the number of days the underpayment remained unpaid from April 18, 2017, through April 17, 2018.
However, this penalty could be waived under various conditions. Check with a tax advisor to be sure.
Safe Harbor Rules for Non Payment of Estimated Taxes
Tax Liability Less than $1,000 – Will you owe $1,000 or more for 2017 after subtracting income tax withholding and refundable credits from your total tax? If the answer is no, then you do not need to file estimated taxes.
At Least 90% of Your Tax is Withheld – Will your income tax withholding and refundable credits be at least 90% of the tax shown on your 2017 tax return? If the answer is yes, then you do not need to file estimated taxes.
At Least 100% of Your Prior Year Tax is Withheld – Will your income tax withholding and refundable credits be at least 100% of the tax shown on your 2016 (prior year) tax return? If yes, then you do not need to file estimated taxes.
Note that these percentages may be different if you are a farmer, fisherman, or higher income taxpayer. Visit the IRS Publication 505 for more on tax withholding and estimated taxes.
Final Thoughts on Estimated Tax Payments
I know calculating your estimated tax payments can be confusing (most tax information is). Many small business owners first turn to a practicing CPA to help them manage this process. I’ve given you a lot to chew on above. Hopefully that will get you started with understanding estimated tax payments. Still, I’d encourage you to seek professional tax advice for your specific situation.