Uncle Sam Wants His Cut of Your Income Before Tax Day! – An Intro to Estimated Taxes
Disclaimer:I am not an accountant, tax preparer or lawyer. The information in this article should not be relied on to anticipate or prepare your tax return. Your situation is unique, consult appropriate professional assistance to determine your tax situation. The information about estimated taxes in this article is based on my experience as an individual taxpayer and my experiences will be different than yours.
If you are new to self-employment, consulting or withholding the minimum tax due from your salary, you may be in for an unpleasant surprise come April 15th.
Uncle Sam, you see, wants to make sure you pay your income tax as you go. Probably based on sad experience, he thinks that most of us won’t save up enough to pay our tax bill if it comes due all at once and we haven’t paid any throughout the year towards it.
He feels so strongly about it, that he lets the Internal Revenue Service penalize us – with – wait for it – more taxes – if we don’t plunk in enough to cover the final bill in time.
What are estimated taxes?
According to the IRS website, estimated tax is simply the method used to pay income taxes on income that is not subject to withholding.
Basically you need to estimate how much you will earn in the coming year and make sure that you have certain amounts of the tax on that amount paid in by certain dates. To quote the IRS “If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return.” How fun is that?
Who should pay estimated taxes?
Anyone or any business that has income that is not subject to withholding will need to consider paying estimated taxes.
For example, to parody Jeff Foxworthy: You may be an estimated taxpayer candidate if…..
- You won the lottery.
- You worked hard to earn extra money by doing freelance work on the side to pay for your wedding.
- You exercised company stock options and didn’t have enough tax withheld.
- Your dividend payouts were great this year.
- You sold some stock at a great profit.
- Your side business made more than $1000.
- You got divorced and started receiving alimony.
- You got a great deal on a foreclosure and started renting it out.
When are estimated taxes due?
April 15, June 15, September 15 and January 15 of the following year are generally the dates that estimated taxes for each quarter come due.
What are the penalties if you don’t estimate?
As mentioned, if the IRS decides you should have paid estimated taxes and you failed to do so correctly in each payment quarter, you get to pay even more taxes, in the form of a penalty. One year our taxes were miscalculated and we ended up with a penalty (I think we got bigger dividend payouts than normal – so it wasn’t all bad news) of around $350. Not terrible, but who wants to pay more taxes than you owe!
Why would you want to estimate?
If all of your income is from salary and is subject to withholding, why would you want to volunteer for the extra agony and effort of paying estimated taxes?
You wouldn’t – if you love letting the government use your money interest free all year. If you get a tax refund each year, you are letting the government use your money interest free all year. Now that isn’t as terrible the past few years since no one is paying interest anyway!
As a general rule, though, you might want to think about keeping the money in your control until it is due, by using estimated taxes instead of having extra withheld.
If you don’t have income tax withheld from your income, Uncle Sam pretty much expects you to estimate and pay as you go – you don’t get a choice, you have to file estimated taxes.
Accountants weigh in! What else should be considered?