The federal tax system is a pay-as-you-go model. Generally, employees meet their tax payment obligations through wage withholding. But there’s no withholding (yet) on self-employment earnings. Usually, self-employed individuals meet their tax payment obligations through estimated taxes. The following are some general questions about federal estimated taxes and what to do.
What are estimated taxes?
Estimated taxes are not a separate type of tax, but rather a way to pay taxes. Unless your current annual tax is minimal (no more than $1,000) or you had no tax liability in the previous year (and meet other conditions), you can’t choose to pay your tax bill when you file your annual income tax return. Doing so likely will result in penalties.
Federal estimated taxes cover not only income taxes but also:
- Self-employment on net earnings from self-employment to pay Social Security and Medicare taxes
- Alternative minimum tax (AMT) if it exceeds the regular tax
- 3.8% on net investment income, including business income for an owner who does not materially participate in company activities (i.e., a passive investor)
- 0.9% additional Medicare tax on net earnings from self-employment and wages if modified adjusted gross income exceeds a threshold amount geared to filing status
- Employment taxes on wages for your household employees
When must estimated taxes be paid?
Estimated taxes, which are made in four installments, are referred to as quarterly payments; they don’t fall neatly each quarter. The payments are due April 15, June 15, September 15, and January 15 of the following year, with the date, extended for a weekend and/or holiday. For 2022, estimated taxes are due April 18, 2022 (April 19 for those in Maine and Massachusetts), June 15, 2022, September 15, 2022, and January 17, 2023.
Note: Those with income from farming and fishing have different estimated tax rules.
How are estimated taxes paid?
Estimated taxes are paid to the U.S. Treasury. You can do so via:
- Check sent by mail, along with a voucher (Form 1040-ES). Caution: Because of IRS backlog, actions may mail make not be credited in a timely manner and you may prefer to use the electronic payment options below.
- Credit or debit card via an IRS-approved service provider. There’s a processing fee for this option.
- Direct Pay authorizes payment from your checking or savings account. It is available only within certain business hours, but no registration is required.
- EFTPS, which enables 24/7 to you authorize payment from your bank account to the extent you specify (the government can’t access your account for any other reason). The benefit of this option is the ability to schedule payments up to 365 days in advance. You have to register to use EFTPS.
You can use your mobile device to access these payment options. Download IRS2Go for this purpose. Or you can call a credit/debit card service provider or EFTPS to authorize payment.
Do not pay estimated taxes for 2022 along with any taxes due for 2021. These are separate payments.
How can estimated taxes be avoided?
To avoid paying estimated taxes, you need to find another way to meet your payment obligation. Some ways to do this include:
- Relying on a working spouse who agrees to increase his/her wage withholding to cover your obligation (assuming you file a joint return).
- Electing S corporation status if you’re a limited liability company (LLC). Doing this lets you take a salary from the business from which withholding can be made.
If you have a job as well as run a business in which you’re self-employed, you can increase withholding from your wages to cover the tax on your business profits.
How much must be paid to avoid penalties?
How do you know at the start of the year what you need to pay? That’s why it’s called “estimated” taxes. You do your best to make projections and can adjust payments throughout the year if things change dramatically. You want to pay as much as necessary to avoid penalties, but not so much that you have to wait for a refund when you file your return for the year. Set aside a portion of earnings—perhaps in a separate bank account—to have the funds on hand to meet your estimated tax needs.
You can rely on a safe harbor to figure out what to pay, which also avoids any underpayment penalties. Pay at least:
- 90% of the current year’s taxes, or
- 100% of the prior year’s taxes (110% if your adjusted gross income in the prior year exceeds $150,000, or $75,000 if married filing separately).
The underpayment penalty may also be waived if the failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.
Work with your CPA or another tax adviser to figure out what you need to pay in estimated taxes. Learn more in IRS Publication 505, Withholding and Estimated Tax