The estimated tax is meant to be paid on any income that is not subject to withholding throughout the year. This type of income includes money earned through self-employment, dividends and interest from investments and banking, rent, prize winnings, alimony and earnings from the sale of assets. This kind of tax must be filed quarterly. Failure to pay enough tax throughout the year could expose you to certain financial penalties.
There are different requirements for estimated taxes if you are a farmer or fisherman. The IRS outlines the special rules pertaining to these occupations in Publication 505.
Required to File Quarterly Taxes
Operating a business as a sole proprietor or performing freelance work will generally mean you’ll have to pay the estimated tax if you expect to owe taxes of $1,000 or more at the time of annual filing. Basically, if you didn’t have to fill out a W-4, you probably have to estimate your tax and file quarterly. Filing as a corporation will typically mean you’ll have to pay estimated taxes if you will likely owe $500 or more in taxes for the year. If you had a tax liability for the year prior, you may also be required to file quarterly. The IRS makes a worksheet available for Form 1040-ES to assist you in determining if you have to pay estimated taxes.
Not Required to File Quarterly Taxes
You usually won’t have to worry about paying estimated tax if you received salary or wages from an employer. If you’re worried your employer isn’t withholding enough to ensure you don’t end up owing $1,000 or more at the end of the year, you can typically avoid having to pay a penalty by amending your W-4 to increase the amount of tax withheld from your wages.
You don’t have to file quarterly taxes if you meet all three of these conditions:
- No tax liability for the year prior (total tax of zero or not required to file)
- U.S. citizen or resident for the whole year
- 12-month period covered by your prior tax year
How to File Your Quarterly Taxes
The first step to paying the estimated tax is to calculate your expected gross annual income. You may find the figures from your prior year’s federal return helpful in getting a ballpark amount to use as a basis. Once you have determined how much you’re likely to earn for the year, you can use the number to figure your taxable income. Then estimate the value of deductions and credits you expect to take for the year, so you can arrive at a reasonable approximation of your annual tax. Stay on top of any changes to your income throughout the year and adjust your figures accordingly.
Once you have determined your estimated annual tax liability, you can use Form 1040-ES to file your quarterly requirement unless filing as a corporation, in which case you would use Form 1120-W. Each period has a due date that must be strictly observed to avoid penalties. Failure to pay enough tax quarterly could cause a penalty to be assessed against you even if you would otherwise be due a refund when you file your annual return. If you estimate your earnings too high or low, you can recalculate your earnings for the following quarter.
The Buck Stops With You
Remember that everyone who earns income is required to pay taxes on that money. If you don’t have an employer withholding enough from your wages to satisfy your tax obligation, it is incumbent upon you to ensure that you are making payments on your own. Carefully calculate your expected earnings for the year from all sources and approximate your tax so you can protect yourself from underpaying and being hit with a penalty.
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