After running our projections for the prior tax year, I found we were slightly short of the minimum withholding for our state taxes. Luckily, there’s an easy way to avoid a penalty for our state, you just send in an estimated tax payment, due on January 15.
In addition, because I quit my job last year, I’m planning to make Federal estimated tax payments for next year. They are easy to do; here’s what you need to know if you are planning to make estimated tax payments this year.
Who Needs to Make Estimated Tax Payments?
Typically, your employer will withhold taxes from your paycheck. If you do not have enough withheld, or if you have other income not subject to withholding, like self-employment income or investment income, you will need to make estimated tax payments.
To avoid penalties, you will need to meet one of the following requirements. You can meet the requirements through withholding, estimated tax payments, or a combination of both. (These rules don’t apply to farmers, fishermen, or higher income taxpayers.)
- Owe less than $1,000 for your taxes.
- Withhold 90% of your tax liability.
- Withhold 100% of your prior year tax liability.
We’re using the last one, because it’s easy to calculate and much lower than our current taxes will be (because we stopped deferring so much retirement income).
How to Pay
There are two options to make payments:
- Use paper Form 1040-ES, available in PDF from the IRS.
- Use the EFTPS, or the IRS electronic system. It only took me five minutes to enroll, although you have to wait 2 weeks to get the PIN and password by mail after you enroll for the first time.
When to Pay
Estimated tax payments are due quarterly. Although, note the spacing is not every three months:
- April 15
- June 15
- September 15
- January 15
If you itemize, and want your state withholding counted for the previous tax year, you can pay your January 15 payment in December.
How Much to Pay
Form 1040-ES includes a worksheet to calculate how much to pay. In addition, most software, like TaxCut and TurboTax include calculators to figure your payments for the following year.
Withholding from an employer is considered to have been paid equally over the year, no matter when the money was withheld. Estimated tax payments are different; there are penalties if a large enough payment is not made during any payment period. See Publication 505, Tax Withholding and Estimated Tax for details on various methods of calculating installments.
I know the answer depends largely on individual tax scenarios (married, kids, other deductions,etc.), but what is a good “rule of thumb” amount to set aside for paying taxes on self-employment income? I’ve heard as high as 30 percent and as low as 20 percent.
Very informative post. For most part time bloggers the most important part is that withholding from an employer is considered to have been paid evenly throughout the year. If you have been slacking in making estimated payments you can talk with your HR company to increase your withholding at the end of the year. Now it’s too late for 2008, but keep it in mind for 2009.
@FrugalDad – wouldn’t the answer depend on your tax bracket?
@ Frugal Dad: Mary is right, there isn’t any way to have a “rule of thumb.” However, you can use your taxes for 2008 once you figure them out. Look at the highest tax bracket that you paid into. Add 15.3% for self employment tax and your state tax rate. For example (15% + 15.3% + 6% = 36.3%). It’s not very exact and doesn’t account for a lot of adjustments, but it’s a good place to start if your income will be about the same.
@ Start-up: That’s what I used to do when I had a job, dump in a bunch in November and December… works like a charm!