Why Should I Make Estimated Payments?

Do you end up paying the IRS each April? Do you get a 1099MISC or work for yourself? If so, making estimated payments may end up saving you money in the long run.

You may make estimated tax payments to pay tax on income that isn’t subject to withholding (such as income from self-employment, the sharing economy, and/or rental activities – think 1099). You may also make estimated tax payments to avoid penalties if the amount of income tax withholding from your salary, pension or other income is not enough to cover your tax for the year.

Taxes are pay-as-you-go, and making estimated tax payments is HOW you pay-as-you-go. Taxpayers use estimated tax payments to pay both income tax and self-employment tax (Social Security and Medicare). If you don’t pay enough tax, through either withholding or estimated tax, or a combination of both, you may have to pay a penalty. The payment of estimated tax for the income for the first quarter of the calendar year (that is, January through March) is due on April 15. Payments for subsequent quarters are due on June 15, September 15 and January 15. If you don’t pay enough by these dates you may be charged a penalty even if you’re due a refund when you file your tax return.

If you also work as an employee, you can often avoid needing to make estimated tax payments by having more tax withheld from your paycheck. This may be a particularly attractive option if, for example, your sharing economy activity is merely a side job or part-time business. To do this, fill out a new Form W-4 and give it to your employer. The Withholding Calculator is a helpful resource.

Example: You file as head of household claiming a dependent son. You take the standard deduction and you expect no refundable credits for 2016. For all of 2016, you worked full-time as an office manager and earned wages from this employment. During the last half of the year, you also went to work for a company that provides transportation through a ride sharing app request and earned $10,000. Federal taxes were not withheld from these earnings.

Your adjusted gross income (AGI) for the year is $95,250. In 2015, your AGI was $74,325 and your federal tax liability was $8,591. You use the Estimated Tax Worksheet and estimate your 2016 federal tax liability to be $11,015. You only had $8,500 in withholding from your wages from your employment as an office manager.

Since your federal tax withholding of $8,500 is less than your total tax for 2015 and your federal tax withheld is less than 90% of your estimated tax ($11,015 x 90% (.90) = $9,913.50), you must increase your withholding or pay estimated tax for 2016. If not, you can expect to be subject to the Estimated Tax penalty when you file your return.