Estimated tax is the method used to pay tax on income that is not subject to withholding, including income from self-employment, interest, dividends, alimony, rent and gains from the sale of assets, prizes and awards. You also may have to pay estimated tax if the amount of income tax being withheld from your salary, pension or other income is not enough.
Both individuals and business owners may need to file and pay estimated taxes, which are paid quarterly. The first estimated tax payment of the year is normally due on the same day as your federal tax return.
For estimated tax purposes, the year is divided into four payment periods, and each period has a specific payment due date. For the 2022 tax year, these dates are April 18, June 15, Sept. 15 and Jan. 17, 2023. You do not have to pay estimated taxes in January if you file your 2022 tax return by Jan. 31, 2023, and pay the entire balance due with your return.
If you do not pay enough by the due date of each payment period, you may be charged a penalty even if you are due a refund when you file your tax return. If you had a tax liability for the prior year, you may have to pay estimated tax for the current year. But if you receive salaries and wages, you can avoid having to pay estimated tax by asking your employer to withhold more tax from your earnings.
Who Has to Pay Estimated Tax
If you are filing as a sole proprietor, partner, S corporation shareholder and/or a self-employed individual, you generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return. If you are filing as a corporation, you generally have to make estimated tax payments for your corporation if you expect it to owe tax of $500 or more when you file its return.
Special rules apply to farmers, fishermen, certain household employees and certain higher taxpayers. If you are in one of these categories, you should check with a tax adviser.
You do not have to pay estimated tax for the current year if you meet all three of the following conditions: (1) you had no tax liability for the prior year; (2) you were a U.S. citizen or resident for the whole year; and (3) your prior tax year covered a 12-month period.
Calculating Estimated Taxes
To figure out your estimated tax, you must calculate your expected adjusted gross income, taxable income, taxes, deductions and credits for the year. If you estimated your earnings too high, simply complete another Form 1040-ES, Estimated Tax for Individuals, using the form”™s worksheet to re-figure your estimated tax for the next quarter. If you estimated your earnings too low, again complete another Form 1040-ES worksheet to recalculate your estimated tax for the next quarter.
If you receive salaries and wages, you can avoid having to pay estimated tax by asking your employer to withhold more tax from your earnings. To do this, file a new Form W-4 with your employer. There is a special line on Form W-4 to enter the additional amount you want your employer to withhold. You had no tax liability for the prior year if your total tax was zero or you did not have to file an income tax return.
Try to estimate your income as accurately as you can to avoid penalties due to underpayment. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits or if they paid at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller.
When figuring your estimated tax for the current year, it may be helpful to use your income, deductions and credits for the prior year as a starting point. Use your prior year”™s federal tax return as a guide and use the worksheet in Form 1040-ES to figure your estimated tax. However, you must make adjustments both for changes in your situation and for recent changes in the tax law.
The easiest way for individuals and businesses to pay their estimated federal taxes is to use the Electronic Federal Tax Payment System (EFTPS). You can make your federal tax payments ”” including federal tax deposits, installment agreement and estimated tax payments ”” using EFTPS.
If it is easier to pay your estimated taxes weekly, bi-weekly, monthly, etc., you can, as long as you have paid enough by the end of the quarter. Using EFTPS, you can access a history of your payments, so you know how much and when you made your estimated tax payments.
This has been a brief discussion of a complex subject and should not be taken as specific advice. Always consider seeking the assistance of a professional on tax matters.
Norman G. Grill is managing partner of Grill & Partners LLC, certified public accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien.
