What are Estimated Taxes?

It’s a fact – taxes are an integral part of our financial lives. In the United States, annual filing is made easier by withholding income tax throughout the year, simplifying the tax return process. However, for some, such as the self-employed or those with irregular income, estimated taxes become a crucial part of their financial management. 

Estimated taxes are quarterly payments made to the Internal Revenue Service (IRS) to cover income and self-employment tax liabilities that are not subject to regular withholding. While employees have taxes withheld from their paychecks, self-employed individuals and businesses must make these payments on their own. Therefore, accurate projections and calculations are needed in order to determine your estimated tax obligations.

In this article, we will explore the concept of estimated taxes, their importance, and how they relate to your tax returns, along with what the IRS expects.

Make Sure to Estimate Accurately

If you expect to owe $1,000 or more in federal taxes after accounting for withholdings and refundable credits, you’re typically required to make estimated tax payments. The IRS gives you two methods to calculate the safe amount to pay, so you’re not penalized later on.

  1. 90% of Current Year’s Tax Liability: This means that by the end of the tax year, your total estimated tax payments should add up to at least 90% of what you owe for that year. If you meet or exceed this threshold, you’re generally in the clear from penalties.
  2. 100% or 110% of Prior-Year’s Tax Liability: You can also avoid penalties if your estimated payments during the year meet or exceed 100% of your tax liability from the previous year. However, if your adjusted gross income was more than $150,000 (or $75,000 if you’re married and file separately), this threshold increases to 110% of last year’s tax bill.

Most individuals and businesses are required to make estimated tax payments in quarterly installments. This means that throughout the year, they must estimate their tax liability and make four equal payments. However, for those living in states like California, there might be additional requirements, so it’s important to be aware of state-specific rules.

Self-employed individuals are especially impacted by estimated taxes, as they have no regular paycheck withholding to cover their tax liabilities. Therefore, careful financial planning is important for meeting these obligations.

The IRS offers several payment methods, including electronic payments, which are fast and secure. To make the process even smoother, estimated tax payment vouchers can be used to accompany your payment.

Working with an Accountant

Managing your finances, especially when it comes to estimated taxes, can often be a complicated process susceptible to costly errors. That’s why it’s important to work with an experienced accountant. Accountants understand the nuances of tax law and financial regulations and can ensure that your tax obligations are met accurately and on time. Here’s how they can help:

  • Accountants can provide accurate projections for individuals and businesses, helping to avoid underestimating or overestimating your tax liability.
  • Accountants offer a layer of protection by ensuring that all IRS requirements are met, reducing the risk of penalties and interest charges.
  • For entrepreneurs and companies, accounting services for businesses can be invaluable. These include financial planning, bookkeeping, and tax preparation. These services can help streamline your financial management and allow you to focus on growing your business.