Estimated Tax

The federal income tax system is a pay-as-you-go system. In other words, instead of paying your entire tax bill when you file your return, you pay your taxes in smaller payments throughout the year.

The pay-as-you-go system is the reason that employers withhold money from the paychecks of their employees (and then hand that money over to the federal government).

Thus, if you are an employee, you don’t have to work too hard to figure out the pay-as-you-go system (as long as you correctly filled out your Form W-4 when you started your job). Your employer will take care of the payments for you.

However, if you are self-employed (or if you are an employee but have other sources of income), you must administer the pay-as-you-go system yourself.

You do so by paying quarterly estimated taxes.

Who Has to Pay

You probably have to pay quarterly estimated taxes if you have income from any of the following sources:

Income from self-employment

Compensation as an independent contractor

Gains from the sale of stock or other property

Royalties

Interest

Dividends

Awards

Any other income for which tax is not withheld

$1,000 Minimum

You have to pay estimated taxes only if you owe $1,000 or more of tax at the end of the year in excess of what you have paid through employee withholding.1

Example. Suppose you owe $12,000 in taxes at the end of the year, and you have already paid $10,000 through withholding (and $0 in estimated taxes). Because your tax liability is $2,000 greater than what you paid, you will face penalties for your failure to pay estimated taxes.

Deadlines

You have to pay estimated tax four times a year, and you will face penalties if you do not pay a sufficient amount by each deadline.2

The deadlines occur 15 days after the end of each quarter.

How long is a quarter? Three months? No.

The tax authorities decided to create four quarters of unequal length.

The payment deadlines are as follows (the dates for calendar year taxpayers are written in bold):3

Quarter 1: 15th day of the fourth month (April 15)

Quarter 2: 15th day of the sixth month (June 15)

Quarter 3: 15th day of the ninth month (September 15)

Quarter 4: 15th day of the first month of the next year (January 15 of the following year)

Note that if the 15th falls on a Saturday, Sunday, or a holiday, your deadline is the first business day after that Saturday, Sunday, or holiday.4

Minimum Amount

To determine how much you must pay each quarter, you can use either of the following methods (see more on these in the next sections):

Pay a percentage of your predicted income for the current year

Pay a higher percentage of the previous year’s income

Remember that withholding counts as estimated tax for this purpose.5 Thus, if you work as an employee in one job and have your own business, you take your withheld income into account when determining your estimated payments.

Predict Your Income for the Current Year

Under the first method, you can avoid penalties if you pay at least 22.5 percent of the amount of tax you will ultimately owe for that year.6

Thus, under this rule, if you want to calculate the correct minimum amount for each quarterly payment, you must:

Determine how much you will owe at the end of the year, and

Pay 22.5 percent of that amount each quarter.

If you use this method and you have unpredictable income, the safest course of action is to overpay. You can get a refund of your overpayments at the end of the year, or you can apply the overpayments to next year’s estimated taxes.7

Use the Previous Year as a Guide

Under your second alternative, you can base your estimated tax payments on the total tax you owed for the previous year.

With this method, you make quarterly payments of at least 25 percent of the amount of tax you owed for the previous tax year.8 (27.5 percent if you earned $150,000 or more during the previous year.9)