Computing Your Estimated Taxes

Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, and rent, as well as gains from the sale of assets, prizes and awards. You may even have to pay estimated tax if the amount of income tax being withheld from your salary, pension, or other income is not enough.

Most people who are regular employees don’t have to worry about estimated taxes, because they have taxes regularly withheld from their paychecks. But if you’re a small business owner who doesn’t draw a salary, then there’s no one withholding taxes from your paycheck for you. And if you’ll owe more than $1,000 in federal taxes at the end of the year, then the IRS requires you to make estimated tax payments four times a year rather than waiting until April 15th to pay it all.

Both individuals and business owners may need to file and pay estimated taxes, which are paid quarterly. If you do not pay enough by the due date of each payment period you may be charged a penalty even if you are due a refund when you file your tax return.

If you are filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, you generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return.

If you are filing as a corporation you generally have to make estimated tax payments for your corporation if you expect it to owe tax of $500 or more when you file its return.

If you had a tax liability for the prior year, you may have to pay estimated tax for the current year. However, if you receive salaries and wages, you can avoid having to pay estimated tax by asking your employer to withhold more tax from your earnings.

When you work for an employer who withholds taxes for you, the IRS knows that it’s going to get most if not all of its tax money during the course of the year. But if you don’t have withholding on your income, the agency fears that you might spend all your money and not have enough to pay them come tax time. So the IRS insists that instead of waiting until you file your tax return to pay all your taxes, you must make quarterly payments in advance.

The trickiest part of making estimated tax payments is figuring out how much to pay. After all, your first payment is due just 4 1/2 months into the year. How do you know at that point how much you’ll make for the whole year and therefore how much you’ll owe in taxes? This is particularly challenging the first year you make estimated payments, since in subsequent years, you can at least make a guess based on the previous year.

To figure out your estimated tax, you must calculate your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. If you estimated your earnings too high, simply complete another Form 1040-ES, Estimated Tax for Individuals, worksheet to re-figure your estimated tax for the next quarter. If you estimated your earnings too low, again complete another Form 1040-ES worksheet to recalculate your estimated tax for the next quarter.

Try to estimate your income as accurately as you can to avoid penalties due to underpayment. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90 percent of the tax for the current year, or 100 percent of the tax shown on the return for the prior year, whichever is smaller.

The IRS says that for most taxpayers, if your estimated tax payments equal at least 90% of the total that you ended up owing for the year, or at least 100% of the tax you paid on the previous year, you won’t get hit with an underpayment penalty. So even if you’ve got absolutely no idea how much you’ll owe for the current year, you can still use the previous year’s numbers to calculate your estimated payments. Even if those payments end up being way off the mark, you won’t owe a penalty.

However, if it turns out that you make way more income this year than the previous one, you’ll end up owing a huge amount in taxes at the end of the year. If you realize mid-year that your estimated tax payments are much lower than the actual taxes you’re accruing, you need to either increase your estimated tax payments or save a lot of money for your final April 15 tax bill.

On the other hand, if your income turns out to be significantly lower than the previous year’s, then your estimated payments using the safe harbor will be way higher than they need to be. Any overpayments that you make for the year will be returned to you in the form of a tax refund when your Missouri tax preparer files your return.

However, you may not want to give the IRS a bunch of your money to hold onto for months and months, so if it becomes clear that your tax bill for the year will be much lower than the previous year’s, you have the option of making your remaining estimated payments smaller than planned. And if it turns out that the first three estimated payments took care of your entire tax bill for the year, you can just skip the final payment on January 15.

If you have any questions about whether you’ll need to file estimated taxes or if you have any questions about how to compute them, please consult your Missouri Certified Public Accountant in our office.