Quarterly Estimated Tax Payments

What Are Quarterly Estimated Tax Payments?

Individuals, including sole proprietors, partners in partnerships, and S corporation shareholders, generally have to make quarterly estimated tax payments if they expect to owe tax of $1,000 or more when they file their Federal income tax return. What that means, is that Congress requires non-W-2 and non-1099-R-type earners to make quarterly deposits of their federal income tax (and states with income taxes follow federal treatment).

The rules for figuring out estimated taxes are complex. Many of our clients get discouraged when they see estimated tax payment worksheets prepared by the IRS. This article is written to assist self-employed individuals and taxpayers with passive income (dividends, interest, and rents) to estimate their tax deposits for the current year.

Exceptions to the Quarterly Estimated Tax Deposits

No estimates are necessary for:

Employees whose sole source of income is reported on Forms W-2 (your employer has done payroll withholding on your behalf),
Individuals with pensions, annuities, and other deferred income whose custodian or retirement plan administrator has done income tax withholding on their behalf,
Certain independent contractors who have backup withholding taken out of the pay they receive,
Taxpayers whose federal income tax will not exceed $1,000 in the current year, and finally
U.S. citizens or residents with no tax liability in the prior year.

The Safe Harbor Rule

Taxpayers who deposit at least 90% of total tax shown on the current year’s return, or 100% of the tax shown on last year’s return (110% for taxpayers with AGI over $150,000), will not be subject to the underpayment penalty. The lesser of these two amounts (90% of the current year tax or 100/110% of the prior year tax) can be deposited in four equal installments, or as early as the taxpayer wishes. Note that the taxpayer who underpays an installment cannot avoid the underpayment penalty by overpaying the next installment / later in the year.

When to Make Estimated Tax Deposits

The estimated tax payments are computed for the following reporting periods and due on the following dates:

For income earned from January 1 to March 31 – make the deposit by April 15,
April 1 to May 31 (note: two months in this period) – make deposit by June 15,
June 1 to August 31 – make deposit by September 15,
September 1 to December 31 (note: four months in this period) – make deposit by January 15 of the following year.

Note: If these due dates fall on a Saturday, Sunday or legal holiday, the payments are due the next business day.

Optionally, taxpayers may estimate their total federal income tax for the year and pay it in four equal installments.

How Much to Pay

Option 1. Follow the worksheet on Form 1040-ES. Now, to the hard part. How much federal and state income tax to deposit? As mentioned earlier, taxpayers may use form 1040-ES to calculate estimated tax payments themselves or have our firm do this work for them. Form 1040-ES can be found here: https://www.irs.gov/pub/irs-pdf/f1040es.pdf

Option 2. Safe Harbor Method. Another option is to use the 90% / 100%(110%) safe harbor method explained above. It’s relatively easy and works for most taxpayers. Deposit ¼ of that amount every quarter or as early in the year as possible, but no less than ¼ of that amount per quarter. Note, taxpayers who underpay installments in earlier quarters cannot “catch up” by overpaying in later installments. They will be subject to the underpayment penalty.

Option 3. Use Last Year’s Average Tax Rate. For clients who do not expect major tax events in the current year (such as sales of assets followed by large capital gains, or significant losses or deductions), the following method works well. Calculate your last year’s average tax rate (that is: total federal income tax shown on line 24 of the last year’s 1040 divided by your gross revenue / income of your business) and apply that rate to the gross revenue / income your business earns during every installment period of this year (3 months, 2 months, 3 months, 4 months of the current year X last year’s average tax rate).

This method is very rough, and it generally eliminates the underpayment penalty altogether or reduces it to a relatively insignificant amount.

The average tax rate method won’t work for:

taxpayers with spouses earning W-2 income (Schedule C or Schedule E income needs to be bifurcated and the tax rate calculated for that income only),
high-income earners whose profits subject to self-employment taxes exceed $142,800 (in 2021) (in this case, self-employment income needs to be computed separately from business income), and
taxpayers with mixed sources of income (for example, passive income [such as dividends, interest, and rental income] is only subject to the Federal income tax, when earned income [on Schedule C, or Form K-1 from the partnership] is subject to both, the Federal income tax and the self-employment tax [currently at 15.3%]). Note that profits / income reported to taxpayers on S Corporation K-1s is only subject to Federal income tax and not subject to self-employment tax of 15.3%. Multiple streams of income require different tax rates to be applied to different streams of income.

Option 4. Give Us a Call. Our firm can assist anyone with the calculation of their estimated tax payments.

Where to Deposit Federal Estimated Taxes?

Federal estimated tax deposits can be made online at the IRS’s website: https://www.irs.gov/payments. Follow the link with Direct Pay or Debit / Credit Card. On the “Reason” page, select “Estimated Tax”, “Form 1040-ES”.

State Estimated Tax Deposits

For taxpayers who reside in states with income taxes, estimated tax payments / deposits requirements generally mirror federal requirements. We recommend you take a look at your state’s website for additional guidance on how / where to make state estimated income tax deposit.