The way our federal tax system is set up we are required to pay tax over the course of the year rather than waiting until April 15. Many of us do not really think about this because tax is generally withheld from our wages. Even if this is the case there are circumstances that may make it necessary to pay estimated tax payments. For instance, you may not have taxes withheld from certain types of income such as self-employment, interest, dividends or capital gains. It could also apply if you do not have enough taxes withheld from your wages. The following information gives further details on, who should pay, what amount to pay, when to pay, and how to make the payments.
Who should pay estimated tax payments?
The easiest way to determine if you may need to make estimated tax payments is to ask yourself a series of questions:
- 1) Do I expect to owe less than $1,000 of income tax for the year? OR
- 2) Will my current income tax withholding and reimbursable tax credits exceed my prior year’s total tax? OR
- 3) Will my current income tax withholding and reimbursable tax credits exceed 90% of the current year’s expected income tax?
If you cannot meet any of the above exceptions, plan on making quarterly estimated tax payments.
Remember farmers and ranchers operate under a completely different set of rules and the above questions do not apply in that industry.
What amount to pay?
The consequence for not having made estimated tax payments is in the form of a non-deductible penalty. This penalty is calculated using a current IRS interest rate of 3.0% subject to change each calendar quarter. Therefore, if the money that you would use to make those estimated tax payments is invested and yielding more than 3.0% after tax, you may decide to wait until April 15 to pay the IRS and keep your funds invested.
The proper application of these rules helps you avoid or minimize the underestimated tax penalty. It does not mean you will never have to pay additional income tax on April 15. The decision that needs to be made is:
- Do I want to pay in the minimum amount possible to avoid payment of the underestimated tax penalty and then pay the balance on April 15, or
- Do I want to pay sufficient taxes during the year so that on April 15 I will neither owe taxes nor be owed by the IRS, as close as possible, or
- Do I want to anticipate a refund because my family has a specific use for the annual tax refund?
If you base your decision on the above questions, estimated tax payments can be set to achieve the desired result. Once you have made your decision it will be necessary to monitor your income during the year. Any additional changes to your income may require adjustments to your current estimated tax payments. Estimated tax payments can be modified at any time during the year to accommodate unexpected changes in income and to help you avoid the underestimated tax penalty.
When should the payments be made?
Your payments for each year are due on the 15th day of April, June, September and the following January. Any payment that falls on a weekend or holiday is due the first non-holiday weekday after that date.
How to make the payments?
Payment options include paying online or by phone. You may also pay by check or money order, or by credit or debit card. You’ll find more information about your payment options in the Form 1040-ES instructions or on the Electronic Payment Options Home Page at IRS.gov.