If you have your own business or are otherwise self-employed (as a freelancer or independent contractor, for example), you need to make estimated tax payments to the IRS throughout the year in order to avoid paying interest and penalties on top of your taxes. But who is required to file estimated taxes, and how do you go about it?
What are Estimated Taxes
Estimated taxes are the taxes on income that is not subject to withholding. Those in the U.S. who are employed by others usually have federal income taxes (and state taxes, where applicable) withheld from their check by their employer. The employer then forwards the amounts withheld along with the employer's contribution to the Internal Revenue Service (IRS).
However, those who are self-employed, including those who work as independent contractors or freelancers rarely have income taxes withheld from their payments. Other income may also not be subject to withholding including, but not limited to:
- Interest and dividend income
- Alimony payments
- Rental income
- Gains from the sale of assets, prizes and awards
- Social Security and unemployment benefits for which taxes were not
Additional Taxes for the Self-Employed
In addition to income tax, those who are self-employed are also required to submit estimated tax payments for their SE (Self Employment) tax.
Self-employment tax (SE tax) is a Social Security and Medicare tax. The current self-employment tax rate is 15.3% and consists of 12.4% for Social Security (old-age, survivors, and disability insurance) and 2.9% for Medicare. This tax is essentially the same as the Social Security and Medicare taxes withheld by most employers, except that employers are required to pay half the tax, whereas those who are self-employed pay both halves.
Only the first $102,000 of your earnings in 2008 is subject to the Social Security portion of the SE tax, but all of your earnings are subject to the Medicare part of the SE tax.
Who Must Pay Estimated Taxes
You must pay estimated tax for 2009 if [u]both[/u] of the following apply:
- You expect to owe at least $1,000 in tax for the current tax year after subtracting any withholding and credits.
- Your withholding and credits are expected to be less than the smaller of: a) 90% of the tax you expect to owe, or b) 100% of your total tax liability shown on the prior year's return.
This would include even those employees who did not have enough taxes withheld from their earnings.
Sole proprietors, partners, and S corporation shareholders usually have to make estimated tax payments if they expect to owe tax of $1,000 or more when they file their federal tax returns, and C corporations if they expect to owe tax of $500 or more when the return is filed.
You do not have to pay estimated tax for 2009 if you meet all three of the following conditions.
- You were not required to pay taxes in tax year 2008
- You were a US citizen or resident for all of 2008
- Your 2008 tax year covered an entire 12 month period
When Estimated Taxes are Due
Estimated tax payments are due 4 times each year according to this schedule (or the next business day if the due date is a legal holiday or weekend day):
- April 15th
- June 15th
- September 15th
- January 15th
Your estimated tax payments do not have to be the same each period.
The payment due April 15th is to represent the estimated taxes you owe for the period from January 1st through March 31st, the payment due June 15th estimates the taxes you owe from April 1 through May 31, the payment due September 15th is an estimate of your taxes owed on income you received from June 1 through August 31, and the payment due January 15th is an estimate of the amount you owe for income received from September 1 through the end of the year.
If you don' pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return. You can also decide to pay your entire estimated tax liability for the year by April 15th (although I'm not sure why you would want to do that).
For 2008 and 2009, If you filed your 2008 Form 1040 or Form 1040A by February 2, 2009, and paid any remaining taxes due, you didn't need to make the payment due on January 15, 2009. For most who are unemployed, this is nearly impossible since all 1099 forms have not usually been received in time to complete the tax return.
If you are a fiscal year taxpayer (your tax year does not follow the standard calendar year), your payment due dates are:
- The 15th day of the 4th month of your fiscal year,
- The 15th day of the 6th month of your fiscal year,
- The 15th day of the 9th month of your fiscal year, and
- The 15th day of the 1st month after the end of your fiscal year.
Like calendar year taxpayers, you do not have to make the last payment if you file your income tax return by the last day of the first month after the end of your fiscal year and pay all the tax you owe with your return.
Calculating Your Estimated Tax Liability
Tax software programs will help you calculate your estimated tax liability. Additionally, the IRS provides instructions and a worksheet for calculating your estimated tax payments, which are filed with IRS Form 1040-ES. You should keep the worksheet for your records and keep records of the dates on which you make your estimated tax payments throughout the year. This information is critical for completing next year's return and you will need it for calculating any interest or penalties resulting from underestimating your tax liability.
How to Pay Your Estimated Taxes
The IRS offers five ways to pay your estimated tax:
- Credit an overpayment on your 2007 return to your 2008 estimated tax.
- Send in your payment (check or money order) with the corresponding payment voucher from Form 1040-ES.
- Pay electronically using the Electronic Federal Tax Payment System (EFTPS).
- Pay by electronic funds withdrawal if you are filing Form 1040 or Form 1040A electronically.
- Pay by credit card using a pay-by-phone system or the Internet.
Each of these payment methods are explained in detail on the IRS website.
