Do I need to make estimated tax payments?
Most people who file a tax return receive the bulk of their income from wages, pension payments, Social Security, unemployment compensation or some other source. Taxes are either automatically withheld or withheld upon the request of the person being paid. But for some people, (especially the self-employed), no tax or not enough tax is being withheld to cover federal and state tax obligations.
If you don’t have at least 90 percent of your tax liability withheld, you are required to make estimated tax payments during the course of the year. If you’re required to make estimated payments, and you ignore it—or don’t pay enough—you will be automatically charged a penalty when you file your return. Often, the easiest way to avoid this is to simply increase the amount your employer withholds from your paycheck. You can also ask Social Security or many other payers to withhold tax or increase the amount they are withholding.
You won’t owe a penalty if the total tax on your return is less than $1,000 or you didn’t have to pay taxes the previous year. You also won’t owe if you had as much withheld as the total tax paid on your previous year’s return. These exceptions are based on your total tax liability (line 60 of the return), not the amount of your refund or the balance that you owe.
When you file your tax return, you’re given credit for these estimated tax payments just like you would if they had been withheld from your paycheck.
So how do I get started?
Start by getting a copy of Form 1040-ES, which is available online at www.irs.gov. Form 1040-ES has detailed instructions and four coupon-sized forms that you submit with your payments to the IRS.
The actual process of paying quarterly is not difficult. Complete each coupon with your name, address, social security number and the amount you are paying. Payments are due on April 15, June 15, September 15 and January 15. If the payment is due on a weekend or holiday, you have until the next business day to mail it. You may either mail it with a check made payable to United States Treasury or pay electronically. Farmers and fisherman have a more lenient payment schedule.
Calculating the correct amount can be vexing, and is often hit-or-miss, especially if the amount of your income varies. The instructions have two worksheets, one for regular income tax and the other for self-employment tax. If you have your taxes professionally prepared, your preparer may be able to help, particularly the first time you calculate this.
The easiest way to avoid a penalty is to pay one-fourth of last year’s tax liability with each of the four payments. (That’s the amount on line 60 of last year’s Form 1040.) While simpler, this isn’t always the most accurate way to estimate your taxes, and you may still end up owing tax or end up having overpaid and have a large refund coming. Another way to make an estimated tax payment is to apply your tax refund to next year’s taxes.
State withholding tax requirements and systems are generally similar. For example, in Illinois, visit http://tax.illinois.gov/Individuals/FilingRequirements/EstimatedPayments.htm and download Form IL-1040ES. For Wisconsin, visit www.revenue.wi.gov/faqs/pcs/estpay.html and use Form 1-ES.
If you made estimated payments, be sure to enter them on line 62 of Form 1040 or tell your tax preparer the dates and amounts of the payments that you made. This is a fairly common mistake. Often times, preparers are going by the slips of paper and other information that you hand them. Most people do not make quarterly payments, so asking about these payments may not be on the preparer’s usual “checklist.” If you don’t enter the payments on your return, the IRS generally catches this and will issue you a refund later.
IRS Publication 505, Tax Withholding and Estimated Tax, contains a lot of detailed information about special situations. It also discusses other strategies for satisfying estimated tax requirements.
