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.
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:
Compensation as an independent contractor
Any other income for which tax is not withheld
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.
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
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)
1 IRC Section 6654(e)(1).
2 IRC Section 6654(a).
3 IRC Sections 6654(c)(2), (k)(1).
4 IRS Publication 505, Tax Withholding and Estimated Tax, published April 8, 2013, p. 28.
5 IRC Section 6654(g)(1). You treat the withheld payments as if you paid them in equal amounts for each quarter.
6 IRC Section 6654(d)(1)(B)(i) (quarterly payments must be 25 percent of 90 percent of year’s tax (25% x 90% = 22.5%). You can change the percentage due at each quarter if you annualize your income. IRC Section 6654(d)(2).
7 IRC Section 6402(b); Reg. Section 301.6402-3(a)(5).
8 IRC Section 6654(d)(1)(B)(ii).
9 IRC Section 6654(d)(1)(C).