Most personal income taxes are generally paid through withholding on your wages or salary. However, you may have also received income from other sources not subject to withholding. Common examples of income sources are alimony, awards, dividend and interest income, money derived from the sale of assets, prize winnings, rental income and self-employment.
Depending on how much you receive and your projected tax liability, you may be required to pay estimates on these types of income. If you do not, you run into a problem with the IRS as it imposes penalties on taxpayers who are required to estimate and don’t ante up or pay less than the required amounts due.
If you find that you owe more taxes, you have two choices: (1) change your withholding from your pay, or b) make estimated payments.
Most states, but not all, require estimated tax payments. Many states’ estimated tax systems are similar to the federal system, but use the state’s tax rates, or exclude certain income items in the calculation, or have a lower income minimum.
How do I figure how much I will owe in estimates?
In most cases, estimated tax payments are due if you expect to owe the IRS $1,000 or more for the year after subtracting tax withholding and credits.
You are going to have to cough up estimates by paying the lesser of:
a) 90% of your total tax due for the current year, or
b) 100% of the tax you paid the previous year.
There are exceptions to this general rule for farmers, fisherman, certain household employees and higher income taxpayers.
If you have an uneven income stream, a drop in income, or changes in your exemptions, deductions, or credits, your required estimated payments will not necessarily be the same for each installment period. You should re-figure your remaining estimated tax payments.
To assist taxpayers in determining their estimated payments, the IRS provides a handy worksheet (download Form 1040-ES. Also helpful is IRS Publication 505.
Who does not have to pay estimates?
You do not have to pay estimates if you
a) Had no tax liability for the previous year and the previous tax year covered a 12-month period. No liability means your total tax was zero or you did not have to file a return, and
b) Were a US citizen or resident alien for the previous year.
Paying estimated taxes (on time)
Estimated taxes must be paid four times during the year during specific payment periods. The payment periods are Jan 1-March 31 (due date Apr 15); April 1 – May 31 (due date June 15); June 1 – August 31 (due date September 15), and Sept. 1 – Dec. 31 (due date January 15, following year). You may pay the entire year’s estimated tax with the first payment.
If you fail to pay your estimated taxes by the due date of each payment period, penalties will apply. Fortunately, if your payment is postmarked on the due date, your payment will be considered on time.