The U.S. has a pay-as-you-go taxation system. Employers withhold income tax from employees every pay period and send it to the IRS to help the government maintain a reliable schedule of income. All they have to do is file by the IRS tax deadline to get a tax refund.
But freelancers and small-business owners usually don’t have a human resources department pulling tax money out of their paychecks, so they have to pay estimated taxes four times per year.
While it’s a little extra work, filing your estimated tax payments each quarter helps you stay on top of your taxes. It also protects you from having to cough up all the dough at once — if you learn to do it correctly.
What Are Estimated Tax Payments?
When you’re an employee, it’s your employer’s responsibility to withhold federal, state, and local income taxes and send that withholding to the appropriate government body. Those are prepayments on your expected tax liability when you file your tax return. Your Form W-2 has the withholding information for the year.
When you file, if you prepaid more than you owe, you get some back. If you prepaid too little, you have to make up the difference and pay more. Employee withholding is based on the most recent Form W-4 filed with the employer’s human resources department.
But if you’re in business for yourself, you need to be your own HR department. That means you may need to make estimated payments. Paying estimated taxes requires you to estimate in advance how much you expect to owe the government in taxes for the current tax year.
You then send in four quarterly payments that together total that amount. The due dates for quarterly estimated payments fall near the middle of the months of April, June, September, and January.
If you don’t make the quarterly estimated tax payments you need to, the IRS will hit you with a penalty for failure to pay estimated taxes. To avoid that, it’s crucial to know if you’re responsible for estimated taxes, how to determine the amount, and how to send your payments efficiently.
Who Needs to Pay Estimated Taxes?
The official rule is that if you expect to owe at least $1,000 in taxes when you file your annual return, you must make estimated tax payments. That probably applies to you if you fall into one of two groups.
- Self-Employed Full-Time Workers & Small-Business Owners. If you file as a sole proprietor, S corporation shareholder, partner, self-employed individual, or single-member LLC, you likely need to pay estimated taxes regularly.
- Freelancers With a Regular Job. If you have a full-time job with tax withholding and also work on the side and you either receive a 1099-NEC or have clients or customers who pay you directly, determine how much of your income is untaxed. If you make a significant amount from your freelance work, you should probably pay estimated taxes.
How to Estimate Your Taxes
If you use tax-preparation software from a company like H&R Block and owe $1,000 or more, the software typically calculates estimated tax payments. It also generates four Form 1040-ES vouchers for you to use to mail estimated payments for the coming year.
Otherwise, follow the IRS instructions on Form 1040-ES to determine how much you should pay in estimated taxes. Form 1040-ES includes vouchers in case you choose to send those payments by mail.
If you receive your self-employment income irregularly throughout the year, you may be able to pay different amounts throughout the year to more closely match your income. To avoid penalties, pay the minimum amount required for the quarter by the quarter’s due date.
You can also make more than four estimated tax payments during the year. You can get a 1040-ES payment voucher to fill out online to send with your extra payment.
Freelancers and independent contractors are frequently surprised at the sizable tax bill they face when they have a nice net profit for the year. The high amount is because they not only pay income tax on the profit, but they have to pay self-employment tax as well. Self-employment tax is part of your overall tax liability and is one thing that makes estimating total tax liability difficult.
There is a formula you can use to figure your self-employment tax. Take your net profit from Schedule C and multiply it by two numbers: 92.35% and 15.3%. The result is your self-employment tax. For example, if your net profit is $10,000, you calculate your self-employment tax as follows: $10,000 x 0.9235 x 0.153 = $1,413.
When it comes time to file your yearly tax return, you will be able to deduct half this amount ($707) from your income. That will reduce your income tax by a small amount, depending on your tax bracket. But when paying your estimated taxes, it’s best to include the full amount of your self-employment tax to ensure you pay enough. Tax software considers self-employment tax when it generates your 1040-ES vouchers.
How to Pay Estimated Taxes
You have a range of options for submitting estimated tax payments.
Registering with EFTPS isn’t complicated. You just need a bank account, Social Security or employer identification number, phone number, and a mailing address. You must use the mailing address the IRS has on file.
The IRS will mail you a PIN in about a week. Using that PIN, you can get into their website anytime to schedule a payment. Once you set up your bank account with EFTPS, you can schedule withdrawals.
If you want to schedule a direct debit, you need tax software with that capability, which many have. You can schedule the amount and date you’d like the payment deducted from your account.
If you want a little help saving money for your quarterly tax payment, you can set up a savings builder account through CIT Bank and move money into it each month. This account is one of the highest-interest-earning savings accounts available.
When to Pay Estimated Taxes
You should pay taxes on the earnings from each quarter after the quarter has ended. However, the quarters aren’t equal — the second quarter is two months, and the fourth quarter is four months.
Estimated tax payment deadlines for 2022 are:
- First Quarter (Jan. 1 to March 31): April 18, 2022
- Second Quarter (April 1 to May 31): June 15, 2022
- Third Quarter (June 1 to Aug. 31): Sept. 15, 2022
- Fourth Quarter (Sept. 1 to Dec. 31): Jan. 17, 2023
Escape the Underpayment Penalty
You may be liable for an underpayment penalty if you pay less than 100% of your tax liability by the tax filing deadline. You can avoid the penalty if you meet one of the exceptions below:
- You’ve already paid — through estimated tax payments or withholding — the lesser of the amount you paid in taxes last year or 90% of what you owe this year. The one exception is that you must pay 110% of last year’s tax liability if your adjusted gross income (AGI) was at least $150,000 (or $75,000 if married filing separately).
- You’re a farmer or fisher, and you’ve paid either the full amount of the tax you paid last year or 66.67% of what you owe this year. The rule about paying at least 110% of last year’s tax liability on an AGI of $150,000 or more does not apply in this case.
- Your tax liability is $1,000 or less for the entire year.
- You had no tax liability last year.
- Your total withholding for the year plus estimated payments you made is within $1,000 of your total tax liability on the deadline.
If you’re a “better safe than sorry” taxpayer and concerned about underpayment, you can either increase your federal income tax withholding if you have a full-time job or overestimate your quarterly tax payments if you’re self-employed. It may feel good at tax time to get a refund, but remember that the money you’re getting back is money you loaned the government at no interest.
The IRS has an initiative called “Pay As You Go So You Won’t Owe” to educate the more than 10 million taxpayers they anticipate will be issued a penalty for not making estimated tax payments. They recommend adjusting your withholding or making estimated tax payments as a way to avoid the penalty.
Think of estimated tax payments as a budgeting tool. They not only make you think about your income and expenses a year in advance, but they also help you budget for your tax payments to avoid a penalty. Budgeting for your payments is one strategy to help manage your cash flow.