Definition
Estimated Tax refers to taxpayers making regular quarterly payments directly to the Internal Revenue Service (IRS) for income not subject to withholding. These payments aim to cover income tax liabilities for the year and prevent taxpayers from accruing large tax debts due to income missed by withholding. Estimated taxes are crucial for self-employed individuals, investors, and others who receive income through means not subject to withholding tax.
Examples
- Self-Employed Individuals: A freelance graphic designer invoices clients for services rendered. The designer receives income without withholding taxes and therefore makes quarterly estimated tax payments.
- Investors: An individual with substantial investment income, including dividends and capital gains, pays quarterly estimated taxes due to the income not being subject to withholding.
- Partners and Shareholders: Members of partnerships or shareholders in S-corporations generally report income on their personal tax returns and may need to make estimated tax payments.
Frequently Asked Questions (FAQs)
What happens if I do not pay estimated taxes?
Failure to pay estimated taxes can result in penalties and interest accrual on unpaid amounts. Taxpayers may use IRS Form 2210 (individuals) or Form 2220 (corporations) to see if they owe a penalty for underpayment.
How do I calculate estimated taxes?
Taxpayers can use the IRS Form 1040-ES worksheet or IRS Publication 505 to estimate their quarterly tax payments based on expected income, deductions, credits, and other tax items.
Are there exceptions to paying estimated taxes?
Yes, there are safe harbor rules allowing taxpayers to avoid penalties if they pay at least 90% of the current year’s tax due or 100% of the prior year’s tax liability, whichever is less.
When are estimated tax payments due?
For individual taxpayers, estimated taxes are generally due four times a year: April 15, June 15, September 15, and January 15 of the following year.
Do corporations pay estimated taxes?
Yes, corporations also pay estimated taxes using IRS Form 1120-W to calculate their payments and filing quarterly estimated payments using IRS Form 2220 for underpayment of estimated tax by corporations.
Related Terms and Definitions
Withholding Tax
A tax amount directly deducted from wages or payments by employers or payers, sent directly to the IRS as partial payment of income tax.
Safe Harbor Rule
Tax regulations providing taxpayers avenues to avoid penalties, such as by ensuring payments are within accepted threshold amounts relative to their tax obligations.
IRS Form 1040-ES
A form provided by the IRS for the use of individual taxpayers to figure and pay estimated quarterly tax payments.
IRS Form 1120-W
A worksheet used by corporations to estimate their tax liabilities and guide quarterly estimated tax payments.
Online Resources
Suggested Books for Further Study
- J.K. Lasser’s Your Income Tax by J.K. Lasser Institute - An extensive guide on tax preparation including estimated taxes.
- Taxes for Small Businesses QuickStart Guide by ClydeBank Business - A guide focused on the needs of small business owners, including quarterly tax payments.
- The Tax and Legal Playbook by Mark J. Kohler - Provides insight into tax strategies, including managing and paying estimated taxes for business owners and investors.
Fundamentals of Estimated Tax: Taxation Basics Quiz
Thank you for exploring the concept of estimated tax and testing your knowledge with our quiz! Keep learning to better manage your tax responsibilities.
