Understanding Estimated Quarterly Taxes

February 21, 2020

In our post on Form 1099, we alluded to the estimated quarterly tax system. Not all Americans pay taxes on an annual tax payment schedule. Not all Americans have only a single due date – April 15th – to keep in mind regarding their tax bill. Some Americans, especially freelancers and independent contractors, have multiple tax deadlines to cope with.

W-2 Filers Have an Advantage

Americans who work for a wage and file Form 1040 are really quite advantaged in a certain way. When an employee receives a wage, that employee has his or her approximate tax liability automatically withheld from his or her wages and pay taxes throughout the year. And in many cases this withholding covers the entire tax balance due to the IRS. This means that, for many Americans, filing a Form 1040 federal tax return is literally the only tax related box to be checked off. Not all Americans enjoy this luxury, however. As a result, many Americans routinely face an underpayment penalty. So, obviously, when it comes to federal taxation, those who have to pay estimated quarterly taxes face a very different situation. 

In this post, we will go over the essentials of the estimated quarterly tax system. We will identify and discuss which taxpayers fit into this system, and also identify the deadlines. We will also discuss the basics of calculating quarterly estimated tax payments. Those taxpayers who are a part of this system do indeed have a much more complicated system to work with than most others. Freelancers and others working within this system need to be a bit more diligent in their preparation and planning efforts in order to avoid an estimated tax penalty.  

Types of Taxpayers Paying Estimated Quarterly Taxes 

There are several types of taxpayers who fit into this system. Among these different types, freelancers and independent contractors are the most common. Freelancers and independent contractors are business people who contract with an entity or individual and receive compensation, yet are not employees. These business people receive a specialized tax form at the end of the year which reports their wages – Form 1099. However, along the way, these business people are required to pay estimated quarterly taxes on their taxable income. The logic underlying this is that annual payments for these business people would be less reasonable.  

Increasing the Probability of Collection

In addition, those taxpayers who expect to have too little tax withheld are also required to make estimated quarterly tax payments. More specifically, those taxpayers who expect to owe at least $1,000 in federal taxes even after withholding and credits, and whose withholding and credits will cover less than 90% of their current total tax or less than 100% of their prior year liability. This makes sense: with the estimated quarterly tax system, the IRS is trying to make sure that they receive the entire sum that they are owed. And they are trying to do so in an efficient manner. Whenever someone ends up owing tax at the close of the tax year, there is always a chance that the IRS will fail to collect. By imposing this federal tax payment system, the IRS is increasing its probability of collection. 

Investment Income

In some cases, those who receive regular investment income from rental property or other investment property (i.e. stocks, etc.) may have to pay quarterly taxes. But this requires a more in-depth analysis than we’re going into today. These are the main types of taxpayers who pay taxes on an estimated quarterly schedule. 

Estimated Quarterly Tax Deadlines & Calculation Methodology 

The exact dates for estimated quarterly tax payments vary from year to year. In every year, taxpayers will make four payments on four dates. These quarterly payments are supposed to approximate one quarter of a given taxpayer’s income for the tax year. For 2020, taxpayers paying quarterly taxes have the following payment dates: April 15, June 15, September 15, and the 15th of January, 2021.

Payment Dates Not Exactly Three Months Apart

Note that these dates are not exactly three months apart from each other. This is not something that those filing quarterly taxes for the first time would expect. Nor is it something that’s particularly convenient to remember. This is one reason why estimated quarterly tax filers should consider hiring an accountant or CPA for tax advice. Taxpayers can decide to make more than four payments if they so desire. This may be optimal for some taxpayers who want to avoid making large lump sum payments. For instance, if a taxpayer wishes to make 12 payments throughout the year, he or she can elect that option.  

Multiple Calculation Methods

There’s also more than one way of calculating estimated quarterly tax payments. Taxpayers can simply estimate their entire yearly income and then divide that sum by however many payments they intend to make. If a taxpayer figures that he or she will owe $20,000 for the year, that taxpayer can simply make four payments of $5,000 each. This method works well for those who have a predictable stream of income.

Other taxpayers can choose to make payments based on the amount they earn at certain points during the year. So, for instance, a taxpayer can choose to make payments each quarter, specifically for the income generated during the quarter. This sometimes makes sense for those with unpredictable income. It’s also worth consulting IRS Publication 505 Tax Withholding and Estimated Tax as a reference. No matter which calculation is made, filers submit Form 1040-ES to the IRS along with their payments. 

Other Good Advice

If you find yourself facing estimated tax penalties because you don’t pay enough tax, consider using tax software to make your calculations. Another good bit of advice is to pay your estimated taxes with through electronic federal tax payment, or EFTP.

Call Us For Assistance

The estimated quarterly tax system is actually quite complex and most quarterly filers hire professional assistance of some sort. Unfortunately, many quarterly filers run into issues because of this complexity. Difficulties with the quarterly system can quickly lead to back tax debt. At Mackay, Caswell & Callahan, P.C., we help clients facing this exact scenario on a regular basis. We’ve helped many clients deal with back tax debt owed to the IRS and rebuild their financial future. If you’re currently dealing with a tax debt problem, don’t hesitate to reach out. Give one of our top New York City tax attorneys a call and we will be happy to assist you. 

Image credit: Mark Turnauckas 

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