Should I Make Estimated Tax Payments to the IRS?

Tax preparation and filing is a fastidious affair. Dollar amounts are entered with precision. Arithmetic is double checked. "Guestimation" is frowned upon.

So why would anyone "estimate" their taxes?

Because if you are self-employed, this is what the IRS wants you to do. Estimated tax payments are used by individuals to report certain withholdings from income that is not subject to withholding on its own.

Wage earning employees have withholdings deducted from their pay through their employer. Form W-4 is used to advise an employer at the rate to withhold; the obligation to do so and to turn over these amounts is entrusted to the individual employer.

Those who are not considered wage earners or statutory employees may not have anything deducted from their pay for federal taxes, Social Security and or Medicare. The responsibility to do so rests with the individual.

Income sources that are typically not subject to federal withholding include non-employee compensation (1099-MISC income), interest and dividends, alimony, rental income, certain capital gains from investments, as well as gambling winnings and monetary prizes. If any of these income sources are high enough, an estimation of the tax due should be sent in to the IRS via voluntary payments.

As a general rule, the IRS sets out this guidance: Estimated tax payments should be paid in during the tax year if both of the following apply.

• If, after subtracting any credits you are eligible for along with any federal withholding from any other income sources, you expect to owe at least $1,000 in tax, and...
• The credits and withholdings are less than 90% of your current tax due or 100% of the tax due on your previous year return,

...Then, you are required to make estimated tax payments.

Here's an example. I expect my gross earnings this year to be $75,000 and I don't expect to be eligible for any credits that will reduce my tax due (these are called refundable credits). My adjusted gross income for last year was $60,000. My total tax due last year was $6,350.

Based on my projected earnings, I estimate that I will owe $7,770. My withholdings from other income sources will only equal $4,000.

I know that I will have to make estimated tax payments during this year because...

1. I am going to owe over $1,000 in tax based on my earnings and,
2. My withholdings of $4,000 will not equal at least 90% of my projected tax due of $7,770.

There is an exception to the above rule. If you had no tax liability for the previous year (meaning you had no taxable income as determined by your earnings, deductions, exemptions and credits), then the IRS will not require you to pay estimated tax for the current year, no matter what amount you earn. However, in order to avoid dealing with a large tax balance come tax time, estimated payments should still be made as needed.

Farmers and fishermen, non-resident aliens, higher income earners (over $150K for joint filers or $75K for single or separate filers) and taxpayers who are legally separated under a decree of divorce or separation maintenance agreement fall under special rules. See Publication 505 for more information.

The easiest way to determine the amount of estimated tax payments to be made is to use an IRS worksheet. The worksheet can be found in various publications. Here is the 2010 ES Worksheet. Instructions can be found in the 1040 Instructions for each year, as well as Publication 505.

When to Make Payments

Estimated tax payments are paid in at least four times a year. The due dates are set; if you miss a payment or make a late payment, the IRS may charge a penalty, even if your total tax is paid in by the last due date. Here are the due dates. Postmark date is considered the paid date.

• For the period of January 1^st - March 31^st, the due date is April 15^th.
• For the period of April 1^st - May 31^st, the due date is June 15^th.
• For the period of June 1^st - August 31^st, the due date is September 15^th.
• For the period of September 1^st - Dec. 31^st, the due date is January 15^th of the next year.

How to Make Payments

A number of options are available to make estimated tax payments. First of all, on your tax return you can elect to roll your refund or a portion of your refund toward next year's tax liability. This is called a credit elect.

If you are sending in voluntary payments according to the above schedule, payments can be made by check or money order, electronically using the Electronic Federal Tax Payment System (See IRS.gov and search the keyword EPAY), or by an electronic debit from a checking account, credit, or debit card.

Check or money order payments mailed in need to be accompanied by a 1040-ES Voucher. If you have made estimated tax payments in the past, you should receive these half-page vouchers in the mail, pre-printed with your name, address and Social Security Number.

Resource: Publication 505, Tax Withholding and Estimated Tax