Whether you’re self-employed or an accountant for a business, it’s essential you make estimated tax payments throughout the year — and that the amount you pay isn’t too high or too low. Paying too much takes income out of your pocket that you could use long before you get it back as a refund. Paying too little subjects you to fines and auditing. To become more skilled at figuring out estimated taxes and to expose yourself to more employment opportunities, find more information about tax LLM programs and earn an advanced degree. In the meantime, follow a few simple tips to determine your quarterly estimated tax payments.
As the IRS explains, you have to pay quarterly taxes if you have any income on which income tax is not automatically withheld by the government. At a small business, that covers most of the profit. As an individual, income could include:
Dividends or gains
Income on interest
Prizes or awards
If you expect to owe less than $1000 at the end of the year, you do not have to pay quarterly taxes; you can wait until you file your annual taxes. However, there is no penalty to pay quarterly taxes even if you think you may owe less than $1000. If you do pay, your goal is not to owe more than $1000 at the end of the year. In other words, if you owe $6000 and you only paid $4000, you’re facing a penalty in addition to that extra $2000. However, if you owe $6000 and you paid $5500, you simply owe the last $500.
Your income is most likely to be similar to the year before. If this isn’t your first year with this income, look at how much you earned and paid last year in taxes. Assume the income is about the same and calculate the amount owed from that total. You should be paying about the same as last year. Although tax laws do change and it’s safer to assume you’ll pay a little more this year.
If your income fluctuates substantially or it’s your first year paying estimated taxes, there’s one trick to guessing how much you’ll earn for the rest of the year:
Look at three months’ income. (Your first quarterly payment is due April 15, so you can wait through March to get an idea of three months’ income.)
Divide the total income by three. This is your average monthly income.
Multiply the average monthly income by 12. This is your estimated annual income. Calculate the total taxes owed from this amount.
If you know you’ll have less or more income during a certain month in the future, adjust the estimated annual income as necessary.
Although paying more than you have to takes more money out of your pocket, if you overpay, you’ll get the money back eventually. If you underpay, you’ll owe hundreds or even thousands more in fees. So it’s safer to project you’ll have a better year and overpay. If you calculate your estimated annual income, you shouldn’t be too far off.
Keep a close eye on your income throughout the year. If it’s proving to be more or less than you anticipated when you decided on your estimated annual income, remember that you’re not locked into a certain amount each quarter. For example, if you’ve been paying $1000 for two quarters and then notice a sharp decline income, expect your total amount owed to be $3000, not $4000. This way, you can pay $500 for both remaining quarters. Likewise, increase payment if your income grows.
The more familiar you are with tax code, the less likely you are to get audited or face penalties and fines. However, estimating your quarterly tax payments doesn’t have to be daunting. Once you’ve established a routine for quarterly tax payments and adjust payment as necessary throughout the year, you won’t have to do much work to avoid fines.
About the Author:
Michelle Gremillion is a certified public accountant and a frequent blogger on tax-related topics.