Who Should Pay Quarterly Estimated Taxes?

By Daniel B. Kline Markets Fool.com

Most people only have to deal with the Internal Revenue Service (IRS) or think about their filing their taxes once a year.

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In general, if most of your income comes from a traditional job where taxes are taken out of your paycheck, and you get a W-2 at the end of the year, that's the case. People in that common situation essentially make little payments to the IRS every time they get paid, and filing their taxes before the mid-April deadline just rectifies any small discrepancies. You may owe a little, you may get a little back, but the paycheck withholding should keep your account in good standing with the tax authority.

However, the self-employed, business owners, and people who have income that has not had taxes deducted from it do not have things so easy. Those people must, in most cases, pay quarterly estimated taxes.

Quarterly tax filers still have to file a full tax form before the annual deadline. Image source: Getty Images.

What are quarterly estimated taxes?

Essentially, it's an educated guess as to what taxes you will owe for the full year. In many cases, freelancers, business owners, and some of the others who pay quarterly estimated taxes get the number wrong, but there is a way to be be incorrect and not have to pay an IRS penalty.

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If your four total estimated tax payments equal 100% of the federal income taxes you paid last year (after all credits and deductions were taken out) you will not be assessed a penalty. However, you will still owe the difference of any underpayment or receive a refund for any over-payment.

Who has to pay quarterly taxes?

The IRS requires quarterly tax payments of anyone who meets the following two requirements:

  • You expect to owe at least $1,000 in tax for the current tax year after subtracting your withholding and refundable credits.
  • You expect your withholding and refundable credits to be less than the smaller of:
    • 90% of the tax to be shown on your current year's tax return, or
    • 100% of the tax shown on your prior year's tax return (unless you make more than $150,000 in adjusted gross income as part of a married couple filing jointly or $75,000 if single or filing separately, in which case the percentage rises to 110%).

There are some exceptions to this for farmers and fishermen (along with a few other specialized cases), but in general, if you think you will owe $1,000 over the course of the tax year, you are required to pay quarterly estimated taxes. This includes taxable income from sources including, but not limited to, interest, dividends, alimony, self-employment income, capital gains, unemployment benefits, some social security income, and prizes (like the cash value of a car or trip won on a game show).

Where estimated taxes get confusing is that for the self-employed, estimated taxes cover not only income tax, but also "but other taxes such as self-employment tax and alternative minimum tax," according to the IRS. Fortunately, the agency offers a fairly simple worksheet (or at least simple by tax form standards) to help you calculate what you owe each quarter.

How and when do I pay quarterly taxes?

The IRS likes to get its money on time, so it's important pay what you owe each quarter, not underpay then catch up in Q4. If you do that, even if you end up overpaying, you could still be assessed a penalty for not paying enough in the previous quarters.

Individuals paying estimated taxes have some choice in when to pay. You can pay the full amount you expect to owe for the year by April 18, 2017. That, of course, might be easier, but it's loaning the government money when you don't have to. The second option is to make four equal payments on April 18, 2017, June 15, 2017, Sept. 15, 2017, and Jan. 16, 2018, though if you file your full tax return by Jan. 31, 2018, you can pay the fourth quarter balance then without penalty.

The IRS also makes it very easy to pay your quarterly estimated taxes. They can be mailed, with an official United States postmark counting as the submission day even if your tax forms arrive at the IRS after the due date.

In addition, the agency offers a number of ways to pay online, including debiting the amount direct from a saving or checking account, which is free, or paying via a credit card, which has fees associated with it. The agency also takes payment from various tax preparation software, and it will even take your payment through outside agencies via phone, though fees apply there as well. If you don't have the money to pay in any given quarter, the IRS also lets people apply for a monthly installment agreement at IRS.gov/payments.

It's about the IRS getting paid

Quarterly estimated tax payments are essentially a way for the IRS to not have to wait for its money from people who do not work jobs where taxes are immediately deducted. Because of that, in addition to using any of the methods above, people can also meet their estimated tax obligations through one other method.

If you also have a traditional job where taxes are withheld, it's allowable to increase your paycheck withholding so it covers your tax obligations on any non-taxed income. For people with a side job, or outside income that's smaller than their traditional job income, doing that (as long as the proper amount is withheld) eliminates the need to file quarterly estimated taxes.

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