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Acting early: The How’s and Why’s of paying estimated taxes

 Acting early: The How’s and Why’s of paying estimated taxes

If you are self-employed, you may be required, or could benefit, from paying estimated taxes.  This method is used to pay tax on income in advance that does not have automatic withholding, as it would if it were a paycheck from an employer, thereby reducing your total payment at the end of the year when you file your tax return.  W.E.D. Tax and Accounting in Chicago, Illinois can help you determine your estimated taxes and pay them on a schedule that reduces your end of year liability.

            Income which you can pay estimated taxes on includes self-employment income, interest income, dividend payments, alimony, rental income, capital gains, prizes, and awards.  You can also pay estimated tax if your withholdings are not high enough.  For example, if you wish to receive your paycheck in a higher amount than your accurate withholdings would allow, you can pay extra estimated tax from your interest or dividend income to balance the difference.

            If you are filing as a sole proprietor, partner, S corporation shareholder, or a self-employed individual, you usually have to make estimated tax payments if you expect to owe tax of $1,000.00 or more.  If you are filing as a corporation, you would make tax payments if you expect to owe $500.00 or more when you file the corporation’s tax return.  If you earn salaries and wages, you can withhold more tax from your earnings and avoid having to pay estimated tax. 

Usually, when you pay estimated taxes, you will divide the year into four payment periods.  Each period has a due date, and you must pay the estimated tax by that date.  If you are paying estimated tax and do not pay by the due date, you can be subject to a penalty.  If you don’t pay enough tax through the year, you can also be subject to a penalty.  If you owe less than $1,000.00 in tax after withholdings and credits, or if you’ve paid 90% of the tax for the year, you can avoid the penalty in certain circumstances.

You can avoid underpayment by paying 100% of the previous year taxes.  If you believe that your income will decrease the following year, you can choose to pay 90%.  There are options available to pay a chunk of your estimated tax right away.  For example, you can pay next year’s estimated tax, or a portion of it, with this year’s federal refund.  You can then divide the remainder into quarterly tax payments.

If you have other income and your withholding will not be enough to cover your tax bill, you should also plan on making quarterly estimated tax payments. This reduces the pressure of making one large payment at the end of the year, and allows you to spread your payments out throughout the year.  The due dates for estimated tax payments are:

First Quarter, January 1st - March 31st :  Due April 15

Second Quarter, April 1st - May 31st: Due June 15

Third Quarter, June 1st to August 31st: Due September 15

Fourth Quarter, September 1st - December 31st :  Due January 15

If you absolutely have issues with paying the estimated tax on time, it’s important to know what the consequences may be.  If you did not have enough withheld, or did not pay enough estimated taxes, your balance is due by April 15th. The IRS uses the date of mailing as the date for payment. If your payment is postmarked by April 15, it's considered on time.  Penalties will be charged if payments are not paid on time, and late payment penalties add up over time and increase as taxes remain unpaid.  If at least 90% of the total taxes owed are not paid by the end of the year, the penalty applies only to the unpaid amount.  This penalty starts at .05% of the unpaid taxes, and increases by the same amount every month the taxes are unpaid.  The penalties stop after they reach 25% of the unpaid amount. However, as long as you file a tax extension by the April 15th due date, you can avoid the penalty.  The tax extension entitles you to six months of additional time to pay the fee.

The IRS now has electronic payment options for your quarterly taxes.  The Electronic Federal Tax Payment System helps you make a payment efficiently.  You use your bank account, social security number, and mailing address to register, then wait for the IRS to send you your pin.  Otherwise, you can mail your payments with a voucher before the due date.

There are many reasons that an individual or business may need to pay estimated tax.  Although common reasons are self-employment, large investment income, major distributions, or large outside income of any kind, you may also need to pay estimated tax if your withholdings are off.  Consult with a professional at W.E.D. Tax & Accounting to ensure that you are using the best possible method for your tax payments.  If you live in the Chicago, Illinois area, and there is a possibility that you owe estimated tax or would benefit by paying estimated tax in advance, contact a W.E.D. Tax & Accounting associate by clicking the link below.


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