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Everything You Need To Know About Quarterly Estimated Taxes
[Prefer to listen? You can find a podcast version of this article here: E176: Everything You Need To Know About Quarterly Estimated Taxes]
Taxes can be stressful. There are a lot of rules and regulations to keep up with and it can be difficult to wrap your head around how to navigate our tax code in the U.S.
This is even more acute for business owners and self-employed individuals. Because not all (or even any) of our income goes through “normal” W-2 payroll, we have additional layers of tax rules to deal with. One of those is quarterly estimated taxes.
Estimated quarterly taxes can be intimidating for taxpayers, but they don't have to be. This guide will explain what estimated quarterly taxes are, how to calculate them accurately, and why it's important to file on time.
What Are Estimated Quarterly Taxes?
Estimated quarterly taxes are payments made by individuals to the government on a quarterly basis to cover their tax liability. These payments are typically made by people who are self-employed, freelance workers, or independent contractors, as well as small business owners who do not have taxes automatically withheld from their income.
The estimated quarterly tax system requires taxpayers to estimate their annual income and tax liability and then make quarterly payments based on those estimates.
Our tax system is a “pay as you go” system. This is why tax withholding is done in every paycheck for W-2 employees. Every chunk of income automatically gets taxes taken out and sent to the IRS.
However, since business owners and self-employed individuals don’t receive W-2 income (or if they do, they still typically have income that does not go through payroll), they need to pay their taxes “manually” through quarterly estimated taxes.
It’s the equivalent of paying taxes through payroll but done directly and outside of a payroll system.
Many retired individuals also need to pay quarterly estimated taxes because their income comes from investments, rather than W-2 income.
Who Has to Make Quarterly Estimated Tax Payments?
So who has to pay quarterly estimated taxes? Typically, the following individuals commonly need to pay quarterly estimated taxes:
- Business owners of an LLC or sole proprietorship
- Business owners of an S-corporation
- 1099 contractors and freelancers
- Retired individuals with income that does not withhold taxes (such as investment income)
- Anyone receiving income that does not go through payroll
So if any of these scenarios apply to you, quarterly estimated taxes may be something you need to stay on top of.
Why? Because taxes are not being withheld from your income automatically. If a client writes you a check or pays you directly in some way, you receive 100% of that income at the time it’s received. But a portion of that income belongs to the government and remember, it’s a pay-as-you-go system. So you need to pay taxes as you go in the form of quarterly estimated tax payments.
So is there a threshold on how much income you need to make before you need to pay? Generally, if you are a business owner, a self-employed individual, or a freelancer and you expect to owe at least $1,000 in federal income tax for the tax year after subtracting any withholding and refundable credits, you may be required to make quarterly estimated tax payments.
When Do I Have to Pay Quarterly Estimated Taxes?
Taxpayers are required to pay estimated quarterly taxes on a schedule determined by the IRS. The due dates for estimated quarterly tax payments are:
- April 15th: Payment for January 1st to March 31st
- June 15th: Payment for April 1st to May 31st
- September 15th: Payment for June 1st to August 31st
- January 15th of the following year: Payment for September 1st to December 31st of the previous year
That's not a typo for the second quarter. The Q2 payment is due on June 15th. The IRS has a somewhat customized definition of what a "quarter" is.
Note that if any of the due dates fall on a weekend or a holiday, the payment is due on the next business day. It's also worth noting that if you file your tax return and pay the balance owed for the previous year by January 31st, you may be able to skip the January 15th payment.
As always, be sure to consult your tax professional for the best route to go in your specific situation.
How to Calculate Estimated Quarterly Taxes
Calculating quarterly estimated tax payments can be tricky. The ideal scenario is to work with a tax professional who can provide you with the right amounts each year.
There are a few other approaches you can take when calculating quarterly estimated tax payments. One approach is to attempt the most accurate calculation. Another way to approach it is the “safe harbor” method.
To calculate your estimated quarterly tax payments with the most accuracy, you will need to estimate your taxable income, deductions, and tax liability for the current tax year. Here are the general steps to follow:
- Estimate your total income for the year. This includes all sources of income such as wages, self-employment income, interest, dividends, and rental income.
- Determine your allowable deductions. This includes expenses related to your business, such as supplies, equipment, and home office expenses, as well as deductions for personal expenses such as charitable donations, mortgage interest, and state and local taxes.
- Calculate your adjusted gross income (AGI) by subtracting your deductions from your income.
- Estimate your tax liability based on your AGI and the current tax rates. The IRS provides tax tables and calculators to help with this.
- Determine the amount of tax you have already paid during the year, including any tax withheld from your paycheck or other income.
- Subtract the amount of tax already paid from your estimated tax liability to determine the amount of estimated quarterly tax payments you need to make.
- Divide the amount of estimated tax payments by four to determine the amount of each quarterly payment.
You can use Form 1040-ES, Estimated Tax for Individuals, to calculate your estimated tax liability and make quarterly payments. The form includes instructions and worksheets to help you estimate your tax liability and determine the appropriate amount to pay each quarter. This will get you closest to your actual tax liability and the proper amounts to pay to avoid a large tax bill at tax filing time.
This is another method of calculating your quarterly estimated tax payments called the “safe harbor” method. This approach does not necessarily mean that you will end up with the most accurate calculations, but it will help you avoid penalties (more on that later).
The safe harbor provision in quarterly estimated taxes is a rule that can protect taxpayers from underpayment penalties if they meet certain criteria for estimated tax payments. Under this provision, taxpayers are not subject to penalties for underpayment of estimated tax if they meet one of the following conditions:
- The taxpayer's estimated quarterly tax payments equal at least 90% of their current year's tax liability.
- The taxpayer's estimated quarterly tax payments equal at least 100% of their prior year tax liability (110% for taxpayers with adjusted gross incomes over $150,000).
If the taxpayer meets one of these safe harbor requirements, they will not be subject to penalties for underpayment of estimated tax, even if their actual tax liability is higher than their estimated payments.
So if you mainly want to avoid penalties and you feel your income will be pretty consistent from year to year, the safe harbor approach could work for you. To do this, you would simply look at your most recent tax return and find the total tax paid (multiply it by 1.1 if your AGI was over $150,000 to get to 110%), and divide it by four to get your quarterly estimated tax payments.
It's important to note that while meeting the safe harbor requirements can protect you from penalties, it may not necessarily result in a lower tax bill. It's always a good idea to carefully estimate your tax liability and make estimated payments that reflect that estimate to avoid owing a large amount when you file your tax return.
There are also some online calculators that can make the process easier, including:
- Estimated (Quarterly) Tax Payments Calculator (Bench.co)
- Quarterly Tax Calculator (Keeper)
- Free Estimated Quarterly Tax Calculator (Acuity)
- Estimated Tax Calculator (FlyFin)
No endorsement, affiliation, or claims of accuracy is implied with any of these services. It’s a good idea to double-check the accuracy of any calculators against another source.
Also note that quarterly estimated tax payments apply to the “household”, so if you file married filing jointly then you would look at the total tax paid on your MFJ tax return.
How to Pay Estimated Quarterly Taxes
So once you’ve calculated your quarterly estimated tax payments, how do you pay them?
You can mail a check to the IRS if that’s your preference. You can do this by sending a check with the mail-in vouchers that are on Form 1040 ES. These vouchers have fields that let you specify the quarter that the payment is for as well as your personal identifying information.
Many people find it easier, however, to pay online. You can go to the IRS payment portal to make your quarterly estimated tax payments online using a bank account. If you haven’t already, this is also a good time to create an online IRS account so you can track your payments and see your tax history online.
You may be wondering if you should pay from your business account or your personal account. The short answer is: you should typically pay from your personal account.
Because most individuals paying quarterly estimated taxes are owners of “pass-through” entities, all taxes are owed by the individual, not the business. LLCs, sole proprietorships, and S-corps are all examples of pass-through entities. In these examples, the business does not owe taxes. The individual owes taxes because the business profit “flows through” to the owner’s personal tax return.
This being said, many business owners still pay out of their business account and their tax pro or bookkeeper adjusts accordingly. But the “correct” way is to pay out of a personal account.
Do Quarterly Taxes Have to Be Paid on Time?
Quarterly estimated tax payments must be made on time to avoid penalties and interest. The due dates for quarterly estimated tax payments are April 15th, June 15th, September 15th, and January 15th of the following year.
If any of the due dates fall on a weekend or a holiday, the payment is due on the next business day.
What Is the Penalty for Not Paying Quarterly Estimated Taxes?
If you fail to make timely quarterly estimated tax payments, the IRS may assess a penalty for underpayment of estimated tax. The penalty is calculated based on the difference between the amount of tax you should have paid through estimated tax payments and the amount you actually paid, minus any refundable credits.
The penalty rate is calculated at the current federal short-term interest rate plus three percentage points and is charged on a quarterly basis for the period of underpayment. As of 2023, the interest rate is 5%.
As a reminder, the IRS requires taxpayers to pay either:
- 90% of the tax owed for the current year, or
- 100% of the tax owed for the previous year (110% if the taxpayer's adjusted gross income was over $150,000)
If you fail to meet these requirements and do not pay the required estimated tax, you may be subject to a penalty of up to 0.5% per month on the underpaid amount, up to a maximum of 25% of the total underpayment. The penalty may be waived if you can show that the underpayment was due to reasonable cause and not willful neglect.
Do Quarterly Taxes Have to Be Equal?
Quarterly estimated tax payments do not have to be equal, but they should be based on your estimated tax liability for the current tax year. Your estimated tax liability is calculated by projecting your income, deductions, and credits for the year and then applying the appropriate tax rate to determine the amount of tax owed.
If your income varies throughout the year, your quarterly tax payments may also vary. For example, if you earn more income in the first quarter of the year than you expect to earn in the other quarters, you may need to make a larger quarterly tax payment for that quarter to avoid underpayment penalties.
If you are using the safe harbor method, however, it may make sense to simply pay each quarter in equal amounts.
How to Plan for Quarterly Estimated Taxes?
Many business owners get behind on their quarterly estimated tax payments because they have not planned ahead for it. Proper cash flow planning can go a long way toward keeping up with your taxes, avoiding surprises, and steering clear of penalties.
Once you start getting behind on taxes, it can be very difficult to get caught up so be sure to plan ahead.
The first step is to calculate your quarterly estimated tax payments for the year. Then, in your personal budget (assuming you are paying out of personal accounts) set aside enough in your cash flow to fund a tax account that you will use to pay your quarterly estimated taxes (including state taxes – more on that later).
Then, when each payment is due, make the payment from your tax account. This way, it’s already been set aside and the quarterly payment doesn’t come out of your cash flow.
Setting aside separate accounts can be a great way to organize your bank accounts to plan for large expenditures.
What if You Own Multiple Businesses?
If you own multiple businesses, the guidelines are still the same. Remember that (assuming your business is a pass-through entity) YOU are paying the taxes, not your business. All income from all sources adds up to result in your total income.
To see how this works, you can look at your tax return where you will see all your income eventually combined into one amount.
What About State Taxes?
Whether or not you have to pay quarterly estimated taxes at the state level depends on the state in which you live and work.
Some states require individuals who are self-employed or have other types of income that are not subject to withholding to make quarterly estimated tax payments. Other states do not require quarterly estimated tax payments, but instead, require taxpayers to pay their state income tax liability in full by the end of the tax year.
To find out whether or not you are required to make quarterly estimated tax payments at the state level, you should check with your state's tax agency or consult with a tax professional who is familiar with the tax laws in your state.
Be sure to learn what your state’s tax rate is and look at your previous state tax return to get a sense of how much your state tax liability is.
Stay Current on Quarterly Estimated Taxes to Avoid Complications
Staying current on quarterly estimated taxes is important because it helps you avoid complications that can arise when you don't pay enough or pay late.
To recap, here are some reasons why staying current on quarterly estimated taxes is important:
- Avoiding Penalties: If you don't pay enough or pay late, you may be subject to penalties from the IRS. These penalties can be significant and can add up quickly, so it's important to make sure you're paying the correct amount on time.
- Managing Cash Flow: Paying quarterly estimated taxes helps you manage your cash flow and avoid a big tax bill at the end of the year. By making smaller, regular payments throughout the year, you can avoid a large lump sum payment and better plan your finances.
- Avoiding Audit Triggers: Failing to pay quarterly estimated taxes can also be an audit trigger. If the IRS notices that you're not paying your taxes on time, they may decide to audit your business to investigate further.
- Accurate Budgeting: Staying current on quarterly estimated taxes can help you accurately budget for your business expenses. By knowing how much you'll owe in taxes each quarter, you can better plan for other expenses and investments.
Staying current on your quarterly estimated tax payments is one of the best ways to lower risk, have peace of mind, and keep your financial situation strong.