As a small business owner or freelancer, the idea of having to pay tax on your income might send shivers down your spine. However, if you do not pay the tax you may be liable to pay a penalty. But, how much do you have to pay? And, how often?
What are Estimated Taxes?
Taxes are pay-as-you-go. If you work for a company, it is standard practice that your taxes are withheld from your salary each month. If you are self-employed or choose not to have your taxes withheld, paying estimated taxes is a good way to make sure that your taxes are paid in full and on time. So that you don’t get a nasty surprise come tax time.
Estimated taxes are a quarterly advance payment on the expected taxes due for that financial year. The amount is calculated on the amount of income earned up until that point.
Who Must Pay Quarterly Taxes?
Every person that earns an income must pay taxes to the federal government. For most people that earn a salary, their employer will withhold their income tax. However, for individuals who are self-employed or earning substantial non-wage incomes, estimated taxes must be paid.
Do I have to make estimated tax payments? You could be liable for making quarterly tax payments if you:
- Are self-employed.
- Earn dividend income.
- Receive alimony payments.
- Earn a substantial retirement income.
- Receive a significant investment income.
- Make a big sum of money. For example, from the sale of a large asset.
How Do I Determine if I Need to Pay Estimated Taxes?
If you are an individual, sole proprietor, partner, or S Corporation shareholder and expect to owe more than $1000 when your tax return is filed, then you are liable for estimated tax payments.
How Do I Calculate Estimated Taxes?
The self-employment tax rate is a percentage of your net earnings from self-employment. The rate comprises:
- 12.4 % for social security
- 2.9 % for Medicare taxes
Self-employed individuals typically pay estimated tax on 92.35 % of their net earnings. The percentage tax paid increases incrementally with an increase in income. Check out this handy worksheet to help you make your calculations.
How Do I Pay Estimated Tax?
You can pay your estimated tax in one of any number of ways:
- Cash at a retail partner.
- Credit card or debit card.
- Direct payment using the IRS site.
- Cheque, cashier’s check, or money order. Payable to U.S. Treasury.
- You can also make payment online via the Electronic Federal Tax Payment System (EFTPS).
You can pay estimated tax quarterly as per the guideline. Or, you can pay more often. For example, once a month. That way your tax deduction forms a part of your monthly budget.
What Are the Due Dates for Estimated Tax Payments in 2020?
Typically, estimated tax payments are paid in four installments at the end of each quarter of the year:
- 1st quarter (January, February, and March) – payment due April 15th
- 2nd quarter (April and May) – June 15th.
- 3rd quarter (June, July, August) – September 15th.
- 4th quarter (September, October, November, and December) – January 15th of the following year.
However, our lives have been turned upside down by the worldwide coronavirus pandemic. The effects are far-reaching. Therefore, the regular systems and dates for making estimated tax payments have been adjusted too.
The amended due dates for estimated tax payments for 2020 are as follows:
- 1st quarter – payment due July 15th, 2020
- 2nd quarter – July 15th, 2020
- 3rd quarter – September 15th, 2020
- 4th quarter – January 15th, 2021
Additionally, if you file your 2020 tax return by February 1, 2021, and make payment in full, you do not need to make the payment due January 15th, 2021.
What Happens If I Pay Quarterly Taxes Late?
We are facing a dire economic situation at present. Many people might be wondering about how to pay taxes when they do not have any money at all. Remember that you do not have to pay estimated tax if you are not earning an income. For example, if you do not have any taxable income for the first two quarters of this year, you will only have to pay estimated tax again at the end of the 3rd quarter, which is September 15th.
What Happens If I Don’t Pay Quarterly Taxes?
To avoid paying interest or the Estimated Tax Penalty for paying too little tax during the year, it is advisable to pay at least 90 % of your tax over the year. If you miss a payment or pay less than the required amount for a payment period, you will be liable to pay a penalty.
What Are the Penalties for Underpayment of Estimated Tax?
The penalty for late payments or underpaying on your estimated tax is calculated individually for each quarter. The underpayment penalty is interest charged on the amount owing. The Internal Revenue Service (IRS) has set the interest rate for underpayments at 5 % for 2020.
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