Estimated Tax Payments
The federal government would like to collect its share of your money as soon as you earn it, but in most cases that is not practical. Instead, the law stipulates that taxes must be paid periodically during the tax year, either through withholding by compensation payers or through the payment of estimated taxes by the payees. However, there is no estimated tax payment requirement for gift taxes. If not enough tax is withheld, then taxpayers must make estimated tax payments commensurate with their total tax liability for a stipulated time. For most individual taxpayers, the applicable installment dates are the 15th of April, June, September, and January, unless the 15th falls on a legal holiday, in which case, the installment date will be on the 1st succeeding business day. Note that the time period is approximately quarterly, but the June and September payments are earlier than a strict quarterly schedule, which would otherwise occur in July and October. A fiscal taxpayer must make estimated payments by the 15thof the 1st, 4th, 6th, and 9th months of the fiscal year. However, the last tax payment for the year in January or for the last payment period of a fiscal year, does not have to be made if the taxpayer files a return before the end of that month and pays the total amount due. So if a calendar taxpayer files a return and pays the entire tax liability by January 31, then the estimated payment on January 15 is not required.
Payments for each installment period are 1st carried back to cover any underpayment in previous installments; any overpayments are applied to the next successive payment period. Overpayments from the previous year can be used to offset estimated tax liability for the current year. Any overpayments of estimated tax cannot be refunded until the taxpayer files for that year. However, instead of a refund, the taxpayer can simply lower current estimated payments by the amount of any overpayment.
When taxes are withheld, the amount withheld depends on the amount being paid by the payer. However, the payer cannot account for other income that the taxpayer may receive. Therefore, taxpayers may be liable for estimated tax payments if other income is received for which taxes have not been withheld, such as income from self-employment and investment income. Tax liability may also arise from the alternative minimum tax (AMT) or because the taxpayer employed household employees, in which case, the taxpayer is obligated to pay at least ½ of the Medicare and Social Security taxes of each employee.
Upper income taxpayers will be liable for additional taxes because of changes in the tax law. There is a phaseout of itemized deductions and personal exemptions based on income. Additionally, there is a new 0.9% Additional Medicare Tax on earned income and the 3.8% Medicare surcharge on net investment income that may also have to be paid through estimated tax payments.
Annualized Estimated Tax Method
If income varies during the tax year, such as for seasonal businesses, then, to avoid the underpayment penalty, the amount owed for each installment period can be annualized, using the Annualized Estimated Tax Worksheet in IRS Publication 505, Tax Withholding and Estimated Tax or by simply following the instructions in Schedule AI of Form 2210. If the taxpayer receives considerably more or less income during an estimated tax period, then the amount can be annualized:
Annualized Income = Taxable Income Received Until End of Estimated Tax Period × 12/(Number of Months from Beginning of Year until the End of the Estimated Tax Period)
For instance, the annualized factor for the 3rd period would be 1.5 = 12 / 8 because the 3rd estimated tax period ends on August 31 so that the estimated tax payment can be made by September 15. If a taxpayer earned $20,000 up to August 31, then the annualized income would be = $20,000 × 12/8 = $20,000 × 1.5 = $30,000. Because the 2nd estimated tax period ends on May 31, the applicable multiplier for the 2nd period is = 12/5 = 2.4.
The general procedure, then, is to:
- take the annualized income,
- apply tax credits and deduct personal exemptions,
- figure what the tax should have been using the annualized income for each installment period,
- account for what has actually been paid for each estimated tax period to determine what the next payment will be.
There is also an annualization procedure for the computation of the self-employment tax in Part II of Schedule AI of Form 2210, if the taxpayer was self-employed. The results of Part II are used in the computations in Part I.
A married couple may pay separate or joint estimated taxes, regardless of whether the final return is separate or joint. However, joint estimated taxes can only be chosen if both spouses are either US citizens or residents and where both are using the same tax year. Joint estimated payments cannot be made if the couple is divorced or legally separated; if the divorce or legal separation occurs after making joint estimated payments, then the joint payments can be allocated between the 2 spouses using the same rules that apply to spouses who file separately. If a couple files separately, but had already made joint estimated payments, then they can decide on how to allocate the estimated payments between them. However, if the couple chooses to file separate estimated tax payments, then any overpayment by 1 spouse cannot be applied to underpayments by the other.
Generally, a married couple can avoid an underpayment tax penalty if sufficient tax has already been paid. A safe harbor provision allows a taxpayer to avoid the underpayment penalty if at least 100%, or 110% if AGI exceeds $150,000 ($75,000 if married filing separately), of tax liability in the previous year was paid or at least 90% of the current tax liability was paid. For a couple who filed separately for the previous tax year but who intends to file jointly in the current tax year, the safe harbor amount is calculated using their combined earnings and total tax owed by both in the previous tax year. So if the wife earned $100,000 and incurred a tax liability of $20,000 last year and the husband earned $125,000, incurring a liability of $25,000, then the 100% safe harbor rule would apply to their total tax liability of $45,000 and their applicable AGI would be their combined earnings of $225,000. In this case, the 110% safe harbor rule would apply, meaning that if they had paid at least 110% × $45,000 = $49,500 in estimated tax payments, then no underpayment penalty would be assessed.
A couple who filed jointly in the previous year but who intend to file separately for the current year must use an allocated amount in determining the prior-year safe harbor by applying a percentage of the tax that would apply had the couple filed separately in the previous year. So if the wife would've paid 75% of the total tax in the previous year if the couple had filed separately, then that is the percentage that the wife must use to calculate the prior-year safe harbor amount and the husband would claim the remaining 25%.
If a spouse dies, then the surviving spouse must continue paying the remaining installments unless the joint estimate is amended. The estate does not have to pay estimated tax, but the surviving spouse and the estate can agree to any allocation of the joint estimated payments; if an agreement cannot be reached, then the IRS will allocate the payments according to what each spouse would have owed.
Tax Tips for Making Estimated Tax Payments
- You can set up automatic ACH payments that will deduct the amounts you specify on the dates you specify by using EFTPS.gov, which is federal government's Electronic Federal Tax Payment System. Select Form 1040 for Individuals, and it will show you the options for scheduling estimated tax payments, using Form 1040ES. Many states also have this same service, which can usually be found through search, using the state or its 2-letter abbreviation and "electronic payment for taxes" as search terms.
- Or pay through IRS Direct Pay. Automatic payments can be set up, or you can use a calendar to remind you to make payments.
- The IRS has a new official mobile app, called the IRS2Go app, available in Google play, Apple's app store, and as an Amazon app. You can pay through IRS Direct Pay from your bank account. It also allows credit or debit card payments through an approved payment processor. Additionally, you can check your refund status within 24 hours after e-filing or 4 weeks after mailing your paper return. And for those taxpayers who qualify, the app can locate the nearest site that offers free tax preparation by the IRS Volunteer Income Tax Assistance or the Tax Counseling for the Elderly. You can also follow the IRS on Twitter and Tumblr, or subscribe to their YouTube channel or to receive IRS tax tips.
- If estimated tax payments are high, use a savings account instead of a checking account to pay, so that the highest interest rate can be earned without incurring any risk of losing principal. So that savings accounts are not used as checking accounts, the law limits fee-free transactions to 6 per month, which should not be a problem with making estimated payments.
- If you have income from which taxes are withheld, but you have received a lump sum that was not taxed and for which you have not paid estimated tax when due, the underpayment penalty may be avoided by having more taxes withheld, which will be allocated equally throughout the tax year, even if the additional withholding occurred at yearend.
- Because the IRS charges a very low interest rate, it may be beneficial not to make estimated tax payments, if the taxpayer is paying higher interest rate on debt or would otherwise incur a greater opportunity cost by not using the funds for something else. The interest rate is usually much lower than what most people pay on credit-card debt or even mortgages. For instance, the long-term applicable federal rate was 5% in January, 2020. The latest figures can be found by using the search terms "interest rate for underpayment of taxes" or by going to https://www.irs.gov/newsroom-index-search?field_pup_historical=1&search=%22interest+rates%22&year=All&field_pup_article_type=All.
- If you overpaid your estimated tax for the 1st 3 payments because your income was lower than predicted, you can skip the final estimated tax payment and still avoid penalties by filing your tax return and paying the remaining amount owed by the beginning of February.
Corporate Estimated Tax
Corporations must also pay estimated taxes if the tax liability for the year is at least $500. Corporate estimated tax payments cover the regular corporate income taxes, alternative minimum tax, and tax on the gross transportation income of foreign corporations from US sources.
The tax is calculated on Form 1120-W, Corporation Estimated Tax, which is not filed with the IRS. Payments are deposited in federal depositories or other authorized financial institutions or through electronic transfers. Corporations must pay 25% of the required annual payment 4 times annually: April 15, June 15, September 15, and December 15. Corporations not classified as a large corporation, those whose taxable incomes did not exceed $1 million for any of the previous 3 tax years, must pay 100% of the current tax year's liability or 100% of the preceding year tax liability to avoid any penalties.