If you're self-employed or own an S corporation, estimated taxes usually are the way in which you pay your federal income taxes. The deadline for 2014 is fast approaching, so get ready now.
1. What are estimated taxes
Estimated taxes are not a separate tax levy, like a sales tax or excise tax. They’re merely a way to pay your taxes on a pay-as-you-go basis rather than waiting until you file your return. Essentially, estimated taxes on self-employment income and for certain other taxes are a substitute for income tax withholding on wages.
2. When estimated taxes are due
Estimated taxes are referred to as quarterly payments, but in reality the payments don’t fall evenly throughout the year. Estimated tax payments for 2014 for individuals are due:
- April 15, 2014
- June 16, 2014
- September 15, 2014
- January 15, 2015
3. What do estimated taxes cover
Estimated taxes include income taxes on your net earnings from self-employment, your share of profits from an S corporation, and on other personal sources of income that are not subject to withholding (e.g., capital gains and dividends on investments).
Estimated taxes also cover:
- Self-employment tax. For 2014, the Social Security portion of this tax applies to the first $117,000 of net earnings from self-employment. The Medicare portion of the tax applies to all net earnings without limit.
- Net investment income tax. This 3.8% additional Medicare tax is owed on the lesser of your modified adjusted gross income over a threshold amount ($250,000 for joint filers; $200,000 for singles; $125,000 for married filing jointly) or your net investment income. Net investment income includes income from a business in which you do not materially participate (you’re merely an investor).
- Alternative minimum tax (AMT). If you’re able to reduce your regular income taxes through legitimate write-offs, you may find yourself subject to the AMT. This “other” tax is paid in place of your regular income tax if it’s more than the regular tax.
- Household employment taxes. If you pay wages to a housekeeper or other domestic worker, you may owe employment taxes (FICA and federal unemployment tax); take these into account.
4. Estimated taxes aren’t only for Uncle Sam
Unless you’re in a state that doesn’t have an income tax, you’ll likely have to figure and pay your state estimated taxes. Payment deadlines usually mirror the federal ones, but check with your state.
5. What happens if you don’t pay enough
Your estimates don’t have to hit a bulls-eye but you have to come close or face a penalty. The good news: the penalty currently is very low (the IRS interest rate used to figure the penalty has remained at 3% since October 2011 and will stay at this rate at least through June 2014).
Here are some ways to avoid any penalty:
- Regardless of your shortfall, peg your current payments to last year’s taxes. There’s no penalty if your 2014 estimated taxes are at least 100% of your 2013 tax bill (110% if your adjusted gross income in 2013 was over $150,000, or $75,000 if married filing separately).
- There’s no penalty if your underpayment is less than $1,000 or your estimated tax payment is at least 90% of your final 2014 tax bill.
- If you or your spouse has wages, increase your withholding (reduce your withholding allowances) so that the withholding will cover what you’d otherwise need to pay in estimated taxes.
- Apply any 2013 refund toward 2014 estimated taxes rather than having the refund given back to you. This may not cover all of your estimated taxes for the year but may enable you to skip the first (or maybe even the second) estimated tax payment for this year.
Don’t be caught short by your estimated tax obligations. Make sure you have the cash on hand to pay your taxes. You can schedule and pay estimated taxes online at no charge using the Electronic Federal Tax Payment System.