Quarterly estimated taxes might seem like a heavy burden since taxpayers have to make calculations and pay four times a year. But typically, estimated tax payments may even reduce the tax burden when it’s tax season. Instead of worrying about paying enough, taxpayers have already paid most if not the entire debt to the IRS.
This article is dedicated to calculating estimated quarterly taxes. You will learn more about estimated taxes by checking comprehensive examples.
Understanding Estimated Tax
Self-employed individuals are expected to calculate and pay their estimated taxes as they don’t have employers who would withhold from their paychecks.
The payment is called “estimated” because you have to estimate how much you will make this year. The IRS expects you to pay taxes on that amount. The calculation includes self-employment, income, and any other applicable taxes.
Who has to Make Estimated Tax Payments?
It’s mandatory to make quarterly payments if a person expects to make $1,000 or more and plans to file as a:
- sole proprietor;
- S corporation shareholder;
- self-employed taxpayer.
Businesses that plan to file as corporations and estimate that they own $500 or more for the year should also make estimated quarterly payments. In case you have any doubts, consider asking for professional help. A certified accountant can help with figuring out these nuances as well as calculating estimated payments.
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Who Shouldn’t Make Estimated Tax Payments?
Regular employees shouldn’t worry about estimated quarterly payments since that’s the job of their employers. If an individual has filled out a Form-W4, then the employer is withholding taxes from their paychecks every month.
There are other groups of people who are employed but shouldn’t pay estimated taxes:
- Taxpayers who don’t owe taxes in the previous fiscal year and don’t have to file tax returns.
- Individuals who were US citizens or residents for the entire year.
- Taxpayers whose tax year was 12 months long.
Individuals have to meet all of these above-mentioned criteria to not make estimated quarterly payments. In all other cases, self-employed individuals have to calculate and pay estimated taxes.
Estimated Taxes Deadlines
The term “quarterly payments” already hints that taxpayers have to pay once every three months, so four times. Payments are usually made on April 15, June, September, and then on January 15 of the next year (for example, in January 2021, you make payment for the year 2020).
If the 15th is a holiday or during a weekend, then the date is the closest business day. In 2022, the schedule looks as follows:
- April 18: to cover January 1 to March 31.
- June 15: to cover April 1 to May 31.
- September 15: to cover June 1 to August 31.
- January 17, 2023: to cover September 1 to December 31.
Consider setting reminders to avoid missing quarterly payments.
Calculating Estimated Taxes
Adding up total tax liability for the entire tear, income, self-employment, any other taxes, and then dividing that number by four gives you estimated tax payments.
The IRS’ Estimated Tax Worksheet (Form 1040-ES), which you may download on the official website, has all the necessary data that helps taxpayers with their calculations. Taxpayers may also use various free estimated tax calculators.
Below you can see a step-by-step guide on what to do to calculate estimated quarterly payments. Let’s assume that a taxpayer, David needs to calculate his payments for the year.
Determine the Taxable Income
As we all know, before taxes are due, we can reduce the taxable income by claiming deductions and credits. But before David claims all his deductions and credits, he must determine how much income tax he must pay for the year. Suppose David makes $80,000 this year. The next step is to subtract any potential deductions Devid thinks should occur during that year. The result will reflect David’s adjusted gross income. Here’s how it looks:
$80,000 (estimated revenue) – $20,000 (deductions) = $60,000
It’s worth mentioning that Devid is single and files as a single taxpayer. David’s next step is to subtract the standard deduction for single taxpayers in 2022, which is $12,950.
David may also substract 50% of his self-employment tax which is $11,303.64 (check the “Calculating Self-Employment Tax” section below to find calculations). It means that David can deduct $5,651.82. So, the calculation is as follows:
$60,000 – $12,950 – $5,651.82 = $41,398.18
David’s estimated taxable income is $41,398.18.
Determine Income Tax
David’s next step is to check his tax bracket. For 2022, he is in the 22% bracket. But it doesn’t mean that David owes to the IRS 22% on his taxable income, which is $41,398. David must pay 10% on his first $9,950, then 12% on $30,574 (from $9,951 to $40,525), and then 22% on $872 (on the amount over $40,525).
So, according to David’s tax bracket, he owes:
($9,950 x 0.1) + ($30,574 x 0.12) + ($872 x 0.22) = $4,855.72
David owes the IRS $4,855.72.
Calculating Self-Employment Tax
According to the IRS, taxpayers who make more than $400 during a specific year have to pay self-employment tax. As you know from section “Determine the Taxable Income” of this article, David’s self-employment tax is $11,303.64. But how did he calculate it?
David had to multiply his estimated total income of $80,000 by 92.35%. This formula enabled David to calculate his self-employment taxable income, which is $73,880.
The next step is to multiply $73,880 by 15.3%. The “15.3%” is the self-employment tax rate. The percentage comes from a combination of Medicare (2.9%) and Social Security tax (12.4%).
So, to calculate self-employment tax total David used the following formula:
$80,000 x 92.35% x 15.3% = $11,303.64
So, David’s estimated quarterly taxes total is:
$4,855.72 (estimated income tax owed to the IRS) + $11,303.64 (self-employment tax total) = $16,159
Adding Everything Together, Dividing by Quarters
The final step is to add everything together to get a total estimated tax, then divide it by four to have estimated quarterly tax payments. David adds his income tax and his self-employment tax for the year and divides this number by four:
- ($4,855.72 + $11,303.64) / 4;
- $16,159 / 4 = $4,040.
So, the total estimated tax is $16,159, and each quarterly payment is $4,040. Now all David has to do is to set reminders in 2022 to make an estimated payment of $4,040 each quarter when it’s due.
If you were using the services of a CPA during previous years, they might send you estimates for this year’s payments per request. But if it’s the first time you calculate estimated quarterly payments, it may be a great idea to contact a CPA.
Moreover, in the article, you will find the “safe harbor” rule description. According to that rule, a taxpayer can use calculations from the previous year and pay 100% on taxable income to avoid penalties.
A certified accountant may calculate your estimated payments once, and then you could use their calculations as an example for the following years.
The most difficult part is calculating estimated quarterly payments. Paying is the easy part. It requires filling out and filing the return form 1040-ES, as well as adding a check to the letter. Send it to the closest IRS office.
It’s also possible to use the IRS Payments Gateway to make all the necessary payments. Corporations should pay through the Electronic Federal Tax Payment System.
Penalties for Missing the Deadline
It doesn’t come as a surprise that the IRS uses penalties for breaking the rules when it comes to paying taxes. The IRS imposes penalties on taxpayers if:
- they failed to pay on time;
- they failed to pay enough.
The best way to avoid penalties in the second case is to pay at least 90% of this year’s tax burden. Another great option is to pay 100% of the taxes owed last year. Even if a taxpayer pays more than they earn, they get a refund. But the main takeaway is that you need to pay on time and enough to avoid any fines.
The “Safe Harbor” Rule
As mentioned, one of the options to avoid penalties is to pay 100% of taxes paid for the previous year. This option is called the “safe harbor” rule. Even if your income grew compared to the previous year, you’ll avoid all fines.
Note: even if a taxpayer avoids penalties, it doesn’t mean they can avoid making those additional tax payments they owe to the IRS. It’s also worth mentioning that if a taxpayer makes more than $150,000 per year, they are required to pay 110% of what they paid the previous year.
Understandably, making estimated payments as a business owner might not be the most desirable course of action. However, it’s possible to plan the budget properly. Doing estimated payments calculations enables entrepreneurs to determine how much they should set aside and use other funds to optimize business operations.
If a taxpayer is self-employed, they most likely have to make quarterly payments when it’s due. It’s safe to say that if an individual doesn’t get a regular paycheck from the employer, then they have to make quarterly payments. There are exceptions to the rule, and they are mentioned in the article.
If it’s not the first time for a taxpayer to make estimated tax payments, then they can benefit from the “safe harbor” rule. According to this rule, individuals may choose to pay 100% of taxes paid for the previous year. For instance, if an individual paid a total estimated tax of $8,900 in 2021, they may choose to pay 100% of that total in 2022.
If you aren’t sure how to calculate estimated tax payments, consider contacting a certified accountant.
Author: Charles Lutwidge