Tips on Estimated Tax Payments
Estimated tax payments are made on any form of income other than a salary or wages. If you are entitled to a salary or wage, your employer will withhold your taxes every time your pay is due, so that what you receive on your paycheck is the net pay. Your employer then passes over these taxes to the IRS and possibly the state government.
If however, you earn an amount of money that is not subject to income tax withholding, you must pay estimated taxes. This applies to income from a business for the self employed, rental income for landlords, interest income, sale of stocks, shares or other assets, and alimony.
Estimated tax payments are made quarterly, which makes it possible for most people to keep up with their tax obligations. Waiting to pay your taxes in full at the end of the year can leave you in arrears if you do not have the money on the ready, leading to penalties. Additionally, these taxes are meant to be paid-as-you-go, hence the quarterly payment arrangement. Failure to file your returns at the specified quarterly payment due dates can lead to penalties.
Use the federal tax Form 1040-ES to calculate your estimated tax payments . You need to factor in your expected gross income, taxable income, credits, deductions and taxes. You can use the tax returns for the previous year to get an estimate of your earnings, credits and deductions. Whatever percentage you plan to pay, try to avoid making an underpayment, which will attract a penalty. There is an approach you can use to get it right.
If you expect to earn the same figure as you earned in the past year, you can pay the same amount of taxes you paid then. If you expect your earnings to be less, pay 90% of the estimated tax payments you made last year. If you pay less than 90% of your previous tax returns but the total of your earnings turn out to be more, you will attract an underpayment penalty. If you anticipate higher earnings in the current year, pay 100% of the tax liability incurred in the previous year. If in both cases you end up having paid more, you will get a refund after the annual compilations are made.
The only way to avoid the underpayment penalty is by paying a minimum of 90% of tax for the current year, 100% of the returns indicated in the previous year or owing tax amounts under $1,000 after deducting credits and withholdings.
If you do not meet these conditions, your penalty may be waived if you were affected by a disaster or casualty, disabled or retired during the tax year. These are the only valid reasons to show that your failure to make payments was circumstantial and not out of neglect.
The only time you are exempt from making estimated tax payments is if your previous tax year covered 12 months and you had no tax liability for the year. You must also have been a U.S resident or citizen for the whole year.
