What Is Estimated Tax?
If you are an employee, you pay taxes as you receive income during the year by having the taxes withheld from your paychecks. If you are working for yourself (self-employed and/or working as an independent contractor), you must pay taxes as you earn income during the year. This way, whether you are employed by someone else or self-employed, you are more or less treated equally for tax purposes.
(FYI: There are other reasons why estimated taxes would be due, but given the audience here, I only talk about self-employment income.)
Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and, to the extent relevant to you, alternative minimum tax (known as AMT).
The estimated tax is paid for the income you're earning this year. So in spring (say, March or April), you may not only work on the tax return for the previous year (e.g., 2017) but also prepare the estimated tax payment for the current year (e.g., 2018). I hope I didn't lose you.
Do I Need to Pay Estimated Tax?
Just like many things in life, it really depends. Taxes are highly personal and dependent on your facts and circumstances. Just like yoga, tax is not one-size-fits-all.
Generally speaking, individuals (including sole proprietors as many yoga teachers and wellness entrepreneurs are) must make estimated tax payments if they expect to owe tax of $1,000 or more when the tax return is filed. (This threshold is lower if the taxpayer is a corporation, at $500.) If your tax was more than zero tax year, you may have to pay estimated tax for the current year.
What is the take away? When it doubt, pay the estimated tax to avoid penalty.
What If I Don't Pay Estimated Tax?
If you do not pay sufficient tax either through withholding or estimated tax payments, you will have to pay a penalty.
Please note that even if you are eventually due a refund when you file your tax return, you may still be charged a penalty if your estimated tax payments are late.
So take this seriously.
How Do I Calculate Estimated Tax?
You need to know the following numbers for you:
- Expected adjusted gross income
- Taxable income
If you expect about the same level of earnings, you can use a prior year tax return for these amounts. But know that this is a good starting point. If there are any big changes since the prior year, you need to take that into consideration.
If you use a tax preparation software, such as TurboTax, it helps you calculate the estimated taxes. Better yet, if you hire a tax professional to prepare your tax return, inquire early to see if he or she can include this service.
When, Where, and How Do I Pay Estimated Tax?
The estimated tax is known as the quarterly estimated tax. So yes, these payments are due quarterly, meaning 4 times a year. It may seen annoying because you have to think about taxes at least 4 times a year!
But consider how often an employee must pay tax. Employees getting paid monthly must pay taxes 12 times a year. Most employees do not get paid on a monthly basis but really every two weeks or twice-a-month. So that is at least 24 times a year. While they do not have to calculate how much tax is being withheld from their paychecks, they pay tax each time they receive income.
Economically speaking, as a self-employed taxpayer, you get to hold onto your income longer if you only have to pay 4 times a year. So consider that a blessing, along with hopefully some additional interest.
Quarterly estimated tax is due around the middle of the following months:
Where & How
You can pay using any of the following 3 methods:
See the "How To Pay Estimated Tax" part of Form 1040-ES for more details and specific addresses for mail-in payments.
What Else Do I Need To Know About Estimated Tax?
Your state may require quarterly estimated tax as well.
For example, here is where you can find more information on California Quarterly Estimated Tax.
I also found an article on QuickBooks but have not verified or clicked through each state's link.
Every week, every two weeks, every month, or whenever you get paid, consider putting in at least 25% (I'd personally recommend 1/3 of every income) into a separate account for tax.
Set aside what must be paid as tax eventually so that you do not get used to thinking it was yours. If you ever think it was yours, even if momentarily, you will get angry (or angrier) when it is time to pay tax.
Just a thought. 🤷