Paying estimated taxes is one way for individuals to submit payments for their taxes to the federal government. Generally, people who run their own business, landlords, investors, and other people may need to pay in estimated taxes if their paycheck withholding won't cover all the taxes that are due. The other payment option is to pay in through withholding. Taxpayers might want to consider adjusting their withholding instead of paying estimated taxes.
You need to pay in at least enough tax through a combination of withholding and estimated payments to avoid the estimated tax penalty. To avoid the penalty, you will need to pay in "at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller," according to the IRS.
The penalty is basically the IRS's way of charging you interest for not paying your taxes throughout the year. The current interest rate for underpayments by individuals is 5%. (The IRS sets this rate each quarter.)
The easiest method for calculating your estimated payments is to divide last year's unfunded tax liability in four, and then make estimated payments using this figure. To do this, look on last year's tax return and find your total tax liability (found on line 63 of the 2007 Form 1040). Then subtract any withholding you expect to pay in for this year. If your withholding will be about the same as last year, you could subtract last year's withholding amount (found on line 64 of the 2007 Form 1040). The difference is the amount of tax that needs to be paid in through estimated taxes to avoid a penalty.
This method, while quick and easy to calculate, does not take into account changes in your income for this year. You might have more income, or more losses, or qualify for different tax deductions. The alternate method that I use personally and with my clients is to run a tax calculation based on this year's income.
Using these annualized income and deduction figures, you will calculate your projected tax liability. You will need to know the current year's tax rates. And you would subtract any withholding or tax credits you will be eligible for in order to find out exactly how much needs to be paid in through estimated tax payments.
To help keep track of these tax calculations, the IRS has a worksheet available with Form 1040-ES (pdf, 7 pages). This worksheet will help you calculate the minimum amount of estimated tax you should pay to avoid the penalty. The worksheet also includes all of the current year figures for standard deductions and tax rates, to help you obtain an accurate figure for this year's estimated payments.
Estimated tax payments are due quarterly.
You need to pay in at least enough tax through a combination of withholding and estimated payments to avoid the estimated tax penalty. To avoid the penalty, you will need to pay in "at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller," according to the IRS.
The penalty is basically the IRS's way of charging you interest for not paying your taxes throughout the year. The current interest rate for underpayments by individuals is 5%. (The IRS sets this rate each quarter.)
The easiest method for calculating your estimated payments is to divide last year's unfunded tax liability in four, and then make estimated payments using this figure. To do this, look on last year's tax return and find your total tax liability (found on line 63 of the 2007 Form 1040). Then subtract any withholding you expect to pay in for this year. If your withholding will be about the same as last year, you could subtract last year's withholding amount (found on line 64 of the 2007 Form 1040). The difference is the amount of tax that needs to be paid in through estimated taxes to avoid a penalty.
This method, while quick and easy to calculate, does not take into account changes in your income for this year. You might have more income, or more losses, or qualify for different tax deductions. The alternate method that I use personally and with my clients is to run a tax calculation based on this year's income.
Using these annualized income and deduction figures, you will calculate your projected tax liability. You will need to know the current year's tax rates. And you would subtract any withholding or tax credits you will be eligible for in order to find out exactly how much needs to be paid in through estimated tax payments.
To help keep track of these tax calculations, the IRS has a worksheet available with Form 1040-ES (pdf, 7 pages). This worksheet will help you calculate the minimum amount of estimated tax you should pay to avoid the penalty. The worksheet also includes all of the current year figures for standard deductions and tax rates, to help you obtain an accurate figure for this year's estimated payments.
Estimated tax payments are due quarterly.
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