Estimated Tax Payments

If you generate income, you must pay taxes. There is really no way around it. However, people generally do not realize that they must pay taxes throughout the year. While income tax is not filed and paid until April 15th of the subsequent calendar year, taxes should be paid as income is collected. There are only two ways to do this. One way is to pay estimated taxes to the government based on income collected. Another way is to have an employer withhold these taxes from pay and remit them to the government.

"Pay-As-You-Go" Tax

Many people have never had to pay estimated taxes since the tax on generated income is withheld and remitted on their behalf by an employer (W-2 income). In fact, I often run into 1099 contractors who have no knowledge of the estimated tax requirement because they are under the assumption that if they earn income, they are not required to pay tax until the tax return is due. Remember, income tax is a “pay-as-you-go” tax. Earning income and not paying any tax on it until year’s end or not paying at all are not great options. 1099 contractors and sole proprietors are examples of individuals who receive income from performing services or selling products and whose income is not withheld by an employer. It is likely that these individuals need to pay estimated taxes throughout the year.

Estimated Tax Requirements

The IRS and most states that impose an income tax, have an estimated tax

requirement. This requirement will vary from jurisdiction to jurisdiction. For purposes

of this article, let’s just focus on federal requirements. The IRS says that anyone who

expects to owe $1,000 or more in income tax must make estimates payments quarterly.

Estimated taxes are due starting with quarter one due on April 15 and the remaining

quarters are due June 15, September 15 and January 15, respectively. To avoid

underpayment penalties, you will need to pay the lesser of either 90% of the current

year income tax or 100% of prior year’s tax throughout the year . If you do not pay

estimated taxes on or prior to the due dates and/or fail to properly estimate those taxes

based on the requirements above, the IRS can and will impose an underpayment

penalty.

Other Considerations

Earning W-2 income does not automatically preclude one from making estimated tax

payments. For example, if you invest some of your W-2 income and receive

interest and dividends, it is possible that the total income generated from these

investments could cause a W-2 employee to have to pay estimated tax. There are cases, as is true with an S Corporation owner, where W-2 withholding and estimated

taxes may be required in the same year.

Conclusion

Regardless of your income status, if you are unsure whether you need to make

estimated payments, it is always best to reach out to your CPA. It is better to be safe

than sorry since underpayment penalties are avoidable and can be steep depending on amount of tax due. If you have any questions about estimated taxes, please reach out to us at abs@westhighlandtax.com or 571-445-0201

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