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Estimated Tax Payments: The Benefits of Pre-Payments

For the majority of taxpaying Americans, taxes are primarily prepaid, meaning most taxes should be paid well before the due date on your annual tax return. In general, taxpayers are either employed or self-employed. The former pay taxes throughout the year through withheld taxes from wages, while the latter must make estimated quarterly tax payments, or risk a penalty. Of course, many Americans work two jobs or earn additional income through investments and side hustles.

Even though you may be paying most of your taxes automatically via withholding, you might still owe additional taxes on your other income. Whether you’re earning additional income or are self-employed, you can send the IRS money in the form of estimated tax payments. If you overpay, the IRS can issue a refund. If you’re short, you can cover the remainder in a timely manner by the end of the tax year, without penalty. However, that doesn’t mean that taxes are set-and-forget.


What Affects My Tax Liability?

Things that can affect your tax liability include a change in employment or a second job, a new source of income (passive or otherwise), the sale of property/realized investment gains, marriage, divorce, and so on.

If you’re not sure if your tax liability has changed in the recent past, you can review your latest tax return information via the official IRS website, and you should try and use the IRS’s tax withholding estimator or hire a tax professional to double-check if your Form W-4 or Form 1040 needs an adjustment.

Any changes in withholding can be incorporated into your tax plan by filling out a new Form W-4 and giving it to your employer. You can change the amount of money you pay in estimated tax via a Form 1040-ES. Remember – any major change in income means a change in how much tax you owe. Tax law changes can also affect your tax liability, such as changes in tax brackets.


Why You Should Pay as You Go

The IRS recommends that taxpayers with a salary who are earning additional income (through investments, interest, alimony, capital gains, awards, etc.) should review their taxable income and determine whether they need to adjust their withholding or make estimated tax payments to cover the tax on their new one-time income before Tax Day.

Pre-payments to the IRS, whenever you’ve received an influx of cash, can keep you out of unexpected trouble with the taxman, especially if you end up forgetting about your windfall and are met with an unexpected bill towards the end of the year. The IRS is not a very forgiving creditor, and the agency has a rather steep interest rate and penalty charge on the tax debt.


Calculating Your Estimated Tax

Individual taxpayers such as sole proprietors, partners, and S corporation shareholders are usually required to make estimated tax payments, so long as the amount of tax they expect to owe on their tax return is more than $1,000.

For corporations, the minimum is $500. The tax form used to file estimated tax payments is Form 1040-ES. You don’t have to pay the estimated tax for 2022 if you had no tax liability throughout any of the months of 2021, i.e., your total tax in 2021 was zero, and you didn’t have to file a return.

When figuring out your estimated tax, utilize the Estimated Tax Worksheet for the current year, as well as the current year Tax Rate Schedules, the IRS’s instructions for the Estimated Tax Worksheet, and your adjusted gross income from last year’s tax.

If your adjusted gross income is $150,000 or less, you must make tax payments equal to 100 percent of last year’s tax liability to avoid underpayment. If your income is more than $150,000, you must prepay 110 percent of last year’s tax liability. Note that you are required to make quarterly estimated tax payments, once every three months.

If you’ve never figured out your own estimated tax before, you can work with a tax professional to ensure that you’re following all the right steps. While the worksheet is self-explanatory, it can be easy to make a mistake or accidentally omit a crucial detail.

As always, keep your standard deduction in mind if you do not plan to itemize. The standard deduction amount in 2022 has been increased from the previous year (to account for inflation) to a total of $12,950 for individuals filing separately, $25,900 for married couples filing jointly, and $19,400 for head-of-household filers.

If you can be claimed as a dependent on another person’s tax return, your standard deduction is reduced to the greater of $1,150 or your earned income plus $400 (up to the maximum of the regular standard deduction). Your standard deduction is also increased by whether you are above the age of 65 and/or blind.

If you are unmarried, you receive an additional deduction of $1,750 per qualification or a total of $3,500. If you are married, regardless of whether you are filing jointly or separately, you receive an additional deduction of $1,400 per qualification or $2,800 in total.

Generally speaking, if you find yourself having difficulty computing or making your quarterly tax payment or your tax deposits for that matter, you should contact a tax professional to assist and make sure you are meeting your tax obligations.


Making Estimated Tax Payments

When making your payments to the IRS, you can either choose to pay online, pay by phone, pay by check/money order, or pay via the app.

To pay online, visit the IRS’s website and navigate to the Payments section, or click the link. The IRS accepts tax payments via IRS Direct Pay, via debit or credit card, via a tax professional or a tax preparation software (Electronic Fund Withdrawal), or via an online payment agreement (if you cannot make a full payment all at once). You can also pay via the IRS2Go app.

To pay by phone, call the IRS’s three authorized payment service providers, which include Link2Gov Corporation (888-729-1040), WorldPay US, Inc. (844-729-8298), and ACI Payments, Inc. (888-872-9829). Alternatively, if you’re enrolled in the Electronic Federal Tax Payment System, you can make a payment via 800-555-4477 (English) or 800-244-4829 (Español). If you are hard of hearing and have a Text Telephone, call 800-733-4829.


What If You Don’t Pay?

If you owe taxes throughout the year and haven’t made any estimated tax payments, you may find yourself subject to a  penalty. You will not be penalized for failing to make estimated tax payments throughout the year if the amount of tax owed through estimated tax payments is less than $1,000, or if at least 90 percent of your total taxes have been paid for.

This means that even if you didn’t make estimated payments for all of the taxes you owe in a year, paying for at least 90 percent via withholding or estimated payments can help you dodge a penalty. The penalty may also be waived if you’ve reached retirement age in the year you didn’t make your estimated tax payments, or if the underpayment was due to reasonable cause (a natural disaster, a close casualty, unusual circumstances, etc.).

If your additional income or full income-eligible for estimated tax payments is received unevenly throughout the year, you can avoid a penalty by annualizing your income and making unequal payments. Forms 2210 (for individuals) and 2220 (for corporations) help taxpayers determine if they underpaid their estimated tax payments.

Just as your life circumstances change, so can your tax liability. The IRS encourages taxpayers to frequently check their withholding and/or estimated tax payments to ensure that they’re accurately covering their yearly tax liability. If you’ve never calculated or paid estimated taxes before, it’s a good idea to start by talking with a tax professional.

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