The tax system in the United States of America operates in the pay-as-you-go mechanism. This implies that taxpayers in the nation are expected to pay a majority of taxes during the year -upon receiving or earning income.
Usually, taxpayers are expected to pay around 90 percent of the overall taxes throughout the taxation year in the form of estimated, additional, or withholding tax payments or any combination of the methods. When taxpayers are not able to achieve this, they might owe some form of estimated tax penalty during tax filing.
According to the IRS, there has been a significant rise in the number of taxpayers that have been subject to estimated tax penalties in the past few years. The penalty amount can differ, but can be several hundred dollars in value.
According to the Tax Cuts & Jobs Act of 2017, there have been changes made in the manner in which tax is calculated for most taxpayers out there -including the ones with substantial income and not subject to withholding.
Due to this, taxpayers are expected to adjust the respective amount of the tax paid during each quarter with the help of the estimated tax system.
What are Estimated Taxes?
Estimated tax can be regarded as the method to pay tax on some income that is not subject to withholding. It would include income out of self-employment, dividends, interests, alimony, gains out of the sale of assets, awards, prizes, and rent. You are also expected to pay estimated tax in case the amount of income tax that is withheld from your pension, salary, or other forms of income might not be enough.
Estimated tax is utilized towards paying income tax as well as self-employment tax along with other taxes & amounts on the respective tax return.
If you are not paying enough with the help of estimated tax or withholding payments, you might be charged a specific penalty. In case you are not paying enough by the due date of every payment period, you will be charged a penalty. It holds true even when you might be due a refund upon filing the tax returns.
Paying Estimated Taxes
When you are filing for taxes in the form of a partner, a sole proprietor, self-employed individual, or S corporation shareholder, you can make use of the Form 1040-ES under the Estimated Tax for Individuals in the PDF format to analyze as well as pay the taxes.
In case you are filing in the form of a corporation, you can make use of the Form 1120-W under the Estimated Tax for Corporations in the PDF format to analyze the estimated tax. You can then go ahead with depositing the desired payments.
Who Should Pay Estimated Tax?
When you are filing in the form of a self-employed, sole proprietor, and a S corporation shareholder, you are usually expected to ensure estimated tax payments if you assume owing a tax amount of $1,000 or more upon filing the tax returns.
When you are filing taxes as a corporation, you are usually expected to ensure estimated tax payments for the corporate when you assume owing the tax amount of $500 or more upon filing the return.
In case you have had a tax liability for the previous year, you are expected to pay estimated taxes for the ongoing year.
Who is Not Required to Pay Estimated Tax?
When you are receiving wages and salaries, you can avoid paying estimated taxes by asking the employer to consider withholding more taxes out of your earnings.
To ensure the same, you should go ahead with filing the new Form W-4 in the PDF format with the respective employer. There is a dedicated line on the Form W-4 that indicates that you can enter the value of the additional amount you wish the employer to withhold.
You are not expected to pay estimated tax for the ongoing year if you are meeting the following conditions:
- You had been the United States resident or citizen for the entire year.
- You did not have any tax liability for the previous year.
- The previous tax year had been capable of covering the 12-month period.
You will have no tax liability for the previous year if the total tax was zero or you were not capable of filing the income tax return. Requirements for estimated tax tend to be different for fishermen and farmers.
Figuring Estimated Tax
To analyze your estimated tax value, you are expected to analyze the expected adjusted taxable income, gross income, credits, and deductions for the respective year.
When you are figuring the estimated tax for the ongoing year, it can be useful to make use of your credits, income, and deductions for the previous year as the starting point. You can make use of the federal tax return of the previous year as your guide. To analyze your estimated tax, you can make use of the worksheet available in the Form 1040-ES in the PDF format.
Through this, you are expected to estimate the exact amount of income you are earning for the given year. If you have estimated that your earnings are quite high, you can simply go ahead with completing another Form 1040-ES worksheet to refigure the value of estimated tax for the upcoming year.
On the other hand, when you have estimated that your earnings are too low, you are expected to complete the Form 1040-ES worksheet again for recalculating the estimated tax for the upcoming quarter.
You should aim at calculating your income as accurately as possible to avoid common tax penalties. You are also expected to ensure proper adjustments -both for specific changes in the situation and for current changes in the respective tax law.
When Should You Pay Estimated Taxes?
For the purpose of estimated tax, the year is divided into dedicated payment periods. Every period features a particular due date for payment. When you are not capable of paying enough tax by the due date of every payment period, you will be charged a penalty even when you are due a refund while filing the income tax return, you will be liable for underpayment of taxes.
When you make use of the EFTPS or Electronic Federal Tax Payment System, it turns out to be the easiest way to pay the respective federal taxes for both businesses as well as individuals.
Ensure the payment of all the respective federal taxes and their payments -including instalment agreement, FTDs (Federal tax Deposits), and estimated tax payments with the help of EFTPS. If it is simpler for you to pay the estimated taxes monthly, weekly, bi-weekly, or quarterly, you can ensure the same -as long as you are paying enough by the quarter’s end.
With the help of EFTPS, it is possible to access the history of the respective payments. This allows you to know when and how much payment was made towards your estimated taxes.
Underpayment of Estimated Tax
When you end up not paying enough tax across the span of the tax year -either by ensuring estimated tax payments or withholding payments, you will have to incur some penalty for underpayment of the estimated tax value. In most cases, taxpayers can look forward to avoiding this penalty when they owe a value of less than $1,000 in the form of tax upon subtracting the credits and withholdings.
This also holds true when taxpayers have paid around 90 percent of the tax for the ongoing year or 100 percent of the entire tax as revealed on the return for the previous year. There are exceptions for fishermen and farmers in this case.
However, when the income is received unevenly throughout the span of the year, you can look forward to avoiding or reducing the penalty amount by annualizing the income and ensuring unequal payments.
You should use Form 2210 under the Underpayment of Estimated Tax by Estate, Individuals, and Trusts, to observe whether or not you owe a penalty for underpayment of the estimated tax. It is recommended to refer to the instructions of the Form 1040 or the Form 1040A about where you should report the penalty for estimated tax on the overall return.
You can also look forward to waiving off the penalty in the following conditions:
- There is a failure to ensure estimated tax payments due to some disaster, casualty, or other uncommon circumstances.
- You have retired (above the age of 62 years) or gained some disability during the taxation year for which there was a requirement of estimated taxes to be paid or in the upcoming year, and the underpayment of taxes was not due to some willful neglect, but due to some reasonable cause.
Get the most of your income by paying estimated taxes on time and being a responsible citizen.
