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“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.” -Benjamin Franklin
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“The difference between death and taxes is death doesn’t get worse every time Congress meets.” -Will Rogers
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My wife and I recently spent time with friends who reside in another town. We spend time together several times each year. During these visits, our conversations range widely from sports, our families, and the economy.
On this particular visit, the subject of taxes surfaced during a conversation. This led to a discussion of estimated taxes.
My friend did not fully understand the concept of estimated taxes, and he was not aware that he paid estimated taxes. He knew he usually received a refund check after filing his tax return. He didn’t understand that his refund check represents the return of excess money paid in estimated taxes each applicable tax year.
He’s not alone! Estimated taxes and tax payments are some of the most misunderstood tax requirements taxpayers face.
Payment of estimated taxes is more problematic for retirees who never paid estimated taxes during their working careers.
For most workers, taxes are automatically deducted from paychecks. The paychecks workers receive are net after withholding for income tax, and the employee share of Social Security and Medicare taxes. Additionally, employers pay their required share of workers’ taxes
Employers must generally deposit employment taxes and report them every quarter. These taxes include withholding from employees paychecks to cover income taxes — federal, and where applicable, state and local — as well as the employees’ share of Social Security and Medicare taxes (FICA).
In addition, employers must contribute their share of FICA and pay federal and state unemployment taxes.
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But, What Happens When These Workers Retire and Become Responsible for Individual Payment of Taxes?
Problems begin when retired workers must assume payment of taxes previously paid by their employers. Retirees are responsible for payment of individual taxes, but they are also responsible for all applicable taxes (including the portion previously paid by the employer).
People unfamiliar with tax payments are uncertain of how much estimated taxes to pay, and the timing surrounding these payments.
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What are Estimated Taxes, and How are They Paid?
Estimated taxes are quarterly payments of tax liability for the year based on the filer’s reported income for the period. Most taxpayers who are required to pay taxes quarterly are small business owners, freelancers, and independent contractors.
Retired people are now responsible for their tax payments. They do not have taxes automatically withheld from their paychecks, as regular employees do.
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Key Takeaways:
- The quarterly filing system requires people and businesses to pay an estimate of the amount they will owe in taxes for that period.
- They also file annual tax returns that determine their exact total taxes due.
- Quarterly filing is required of those who do not have taxes withheld from their incomes automatically.
Everyone is required to pay federal government taxes as they earn or as they receive income during the year. In other words, income taxes are pay-as-you-go.
Those who are employed have taxes withheld from their paychecks by their employers based on the W-4 Forms that the employees complete. Others need to make these payments directly to the government through an estimated tax, rather than waiting until the end of the year to pay when they file their annual tax return.
Estimated taxes are usually paid every quarter. The first quarter is the three calendar months of January 1 to March 31. The second quarter is only two months (April 1 to May 31). The third is the next three months (June 1 to Aug. 31), and the fourth covers the final four months of the year (These installment payments are generally due on April 15, June 15, and Sept. 15 of the current year and on Jan. 15 of the following year).
If the estimated taxes that are paid do not equal at least 90% of the taxpayer’s actual tax liability (or 100% or 110% of the taxpayer’s prior-year liability, depending on the adjusted gross income), interest and penalties are assessed against the delinquent amount.
The easy button here is to use the default approach of paying 110% of the prior year tax liability divided into four quarterly payments. This avoids interest in penalties being assessed when the actual tax burden is determined.
No tax is payable if an individual filer’s net earnings are less than $400. If their net earnings exceed $400, an estimated tax must be paid on the entire amount. Individuals must still file a tax return even if they earned less than $400, as long as they meet certain eligibility requirements.
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Estimated Tax for Business Owners
Individuals, including sole proprietors, partners, and shareholders of S Corporations, must make estimated tax payments on business ownership earnings if the total tax on built-in gains, excess net passive income tax, and investment credit recapture tax is $1,000 or more. Corporations must pay estimated tax if the business is expected to have at least $500 in tax liability.
In addition, employees who had too little tax withheld and thus owed taxes to the government at the end of the previous year are responsible for making estimated tax payments. IRS Form 1040-ES is used to calculate and pay estimated taxes for a given tax year. A taxpayer without tax liability for the prior year, who was a U.S. citizen or resident for the whole year, and had the prior tax year cover a 12-month period, does not have to file Form 1040-ES.
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When Are Estimated Taxes Due?
Installments for estimated tax payments are due on April 15, June 15, and Sept. 15 of the same year and Jan. 15 of the following year.
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Who Pays Estimated Taxes?
People who are self-employed, independent contractors, investors who receive dividend income and generate capital gains, bondholders who get interest income, writers who earn royalties on their work, and landlords with rental income are examples of taxpayers who must pay estimated taxes. Other examples of income liable for estimated tax include taxable unemployment compensation, retirement benefits, and any taxable portion of Social Security benefits received.
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Final Thoughts
Estimated tax is a quarterly payment for self-employed people and business owners who do not have taxes automatically withheld.
Estimated taxes may be made for any taxable income not subject to withholding, including earned income, dividend income, rental income, interest income, and capital gains.
The Internal Revenue Service (IRS) requires quarterly estimated tax payments to be filed by those who have income that is not subject to automatic withholding. The taxpayer then files the usual tax paperwork for the full year and pays the balance due or requests reimbursement for an overpayment.
Taxpayers may avoid potential interest, and penalties by paying 110% of the prior year tax liability divided into four quarterly payments.
The IRS often extends filing and payment deadlines for victims of disasters like hurricanes, floods, and wildfires. If you’ve been affected by such a disaster, you can consult IRS Disaster Relief Announcements to determine your eligibility for an extension.
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