So many people – especially newly divorced single moms and first-time freelancers – end up in tax trouble for one common reason: They don’t realize they need to make estimated tax payments.
So if you:
- Started a business
- Have a side gig
- Got unemployment
- Work from home as a freelancer
- Have any 1099-NEC or 1099-MISC income
- Have investment income
- Take money out of a retirement account…
You could get a nasty surprise at tax time, unless you do something proactive to prevent it…
Make quarterly estimated tax payments during the year.
Any time someone pays you at least $600 during the year, you should receive either form 1099-NEC or 1099-MISC. 1099-NEC is for “non-employee compensation,” and covers most freelancing, consulting, and side gig income. 1099-MISC covers “other” – miscellaneous – types of income, such as royalties, rents, and prizes.
What are estimated tax payments?
When you have a regular job with a regular paycheck, they take out taxes – a lot of taxes, including:
- Federal income tax
- Social Security tax
- Medicare tax
But if your income comes from other taxable sources like freelancing or unemployment, no one is managing those taxes for you, so they’re going unpaid. The IRS doesn’t like that, and they’ll charge interest and penalties on the unpaid taxes at the end of the year… unless you make estimated tax payments.
Every quarter, you’ll send a payment into the IRS for around 25% of your expected year-end tax bill. And we’ll talk about how to figure out how much to pay in just a minute… because it’s important to come up with a good estimate.
If you blow off those quarterly payments or don’t pay enough, you’ll end up with a huge tax bill at tax time. And it will be even bigger once the IRS slams you with interest and penalties. In fact, the IRS will charge extra fees kick in if you’re even one day late. So set a reminder, put it on the calendar, whatever you have to do to make sure those quarterly estimated tax payments get sent in on time.
Estimated Tax Payment Due Dates
|Payment 1||April 15|
|Payment 2||June 15|
|Payment 3||September 15|
|Payment 4||January 15|
When the 15th falls on a weekend or holiday, your estimated tax payment is due on the next business day.
Why a good estimate matters
The IRS is fussy about estimated tax payments, which are required if you’ll have a tax bill of at least $1,000 for the tax year. Not only do they insist you pay on time, they also expect your payment to be “enough.” So even if you make an on-time payment, if they think you underpaid, you could still get hit with penalties and interest (but just on the underpayment amount).
That’s why it’s so important to come up with a good estimate. You don’t want to overpay, and give the IRS more of your money than absolutely necessary. But you also don’t want to underpay, and give them an excuse to pile more on to your tax bill.
How to come up with a good estimate
If you used tax software to do your taxes last year, it probably has an estimated tax input screen where you can enter this year’s numbers. That will help you with all of tax math, but you still have to put in the right information to get realistic estimates. If you didn’t file or do your own taxes last year, you can still figure this out.
To come up with a good estimate on your own, you first have to figure out how much taxable income you expect to get for the whole year. Add up all of your expected income from every possible source. Make sure to include any regular job income (that already has tax taken out) when you’re figuring this out because it might change your tax rate.
Don’t include any money you have coming in that’s NOT taxable, like child support or garage sales.
Once you have all that income information pulled together, head over to the IRS Form 1040-ES, which will walk you through the math.
It’s easy to avoid underpayment penalties
Trying to figure out the right amount of tax to pay can be nerve-wracking, and it feels even worse if you’ve never done it before or have had a major change in income. And the thought of getting hit with penalties can bring on anxiety… especially for people who don’t have the extra money to spare.
But there’s a very easy way to avoid underpayment penalties: Pay at least the amount of taxes you paid last year.* That way, even if you do end up owing – even if you owe a lot – the IRS won’t charge the penalty. This is called the “safe harbor” requirement,” and meeting it can help reduce some of your tax anxiety.
*If your AGI (adjusted gross income) was more than $150,000 last year, you have to pay 110% of last year’s total tax bill to avoid the underpayment penalty.
If your total taxable income will be substantially lower this year, and you know your tax bill won’t even come close to last year’s, aim to pay at least 90% of your current year’s tax bill. If you hit that 90% mark and owe less than last year, the IRS won’t charge a penalty.
Avoid estimated tax underpayment penalties by paying:
100% of last year’s tax
110% of last year’s tax if you made more than $150,000
90% of this year’s tax bill
If you also get a regular paycheck: To avoid the hassle of filing estimated taxes – and never worry about being late – you can increase your withholding taxes to cover the amount you’ll owe. All you have to do is fill out a new Form W-4 with your employer, and do quarterly check-ins to make sure you’re still on track to meet the safe harbor requirements for the year.
How to figure out your estimated tax payments
When you figure out and file your estimated tax payments, you’ll use IRS Form 1040-ES . The form comes with an instruction booklet that covers absolutely everything about how to do the calculations and where to send your check/how to pay online. You can also try their online worksheet to help with some of the math.
But here’s what you really need to know to do the math part.
Step 1: Figure out your expected self-employment income and self-employment taxes if you freelance, consult, or have your own business.
Step 2. Add up all of the taxable income you expect to bring in this year.
Step 3. Add up the things that will reduce your AGI (adjusted gross income), which include:
- Half of self-employment taxes
- Traditional IRA contributions
- Self-employed retirement plan contributions
- HSA (health savings account) contributions
- Self-employed health insurance deduction
- Student loan interest deduction
- Educator expenses
Step 4. Subtract Step 3 from Step 2 to get your expected AGI.
Step 5. Subtract either the standard deduction or your itemized deduction from the AGI you calculated in Step 4. The standard deduction for 2021 is $18,800 if you file as Head of Household or $12,550 if you file as Single.
Step 5. Use the IRS tax rate schedules to figure out your estimated tax bill. You’ll find those tax rates in the instructions for Form 1040-ES. Use Schedule X if you’re filing Single or Schedule Z if you’re filing as Head of Household.
Step 6. If you will owe self-employment taxes, add them to the result you got in Step 5.
Step 7. Total up your expected tax credits, which may include (among others):
- Child tax credit
- Child care credit
- Earned income credit
- Education credits
Subtract your total expected tax credits from the estimated tax you calculated in Step 6.
The result here is your estimated tax bill for the whole year.
Step 8. If you have already had income taxes withheld this year (like through a paycheck) or if you expect to have income taxes withheld going forward, subtract the total income tax withholding you expect from the result you got in Step 7.
Step 9. If the result you got in Step 8 is greater than $1,000, you’ll have to make estimated tax payments. Divide the amount from Step 8 by 4 to figure out the amount to send in each quarter.
Don’t forget state taxes!
If you need to pay estimated federal income taxes, chances are you’ll need to pay estimated state income taxes as well – though every state has its own rules and requirements. Check with your state income tax office to find out the rules that apply to your situation.