The IRS philosophy is when you get paid, they get paid. If that does not happen, interest and penalties are assessed. You absolutely need to pay most of your tax bill during the year or as income is received. This is really an issue for self employed individuals, business owners and investors.
Many times, the reason these taxpayers don’t make estimated tax payments is because they don’t know how much to pay, when to pay or how to pay. The income from one year, may not be a fair representation of income of the following year, which makes it difficult to calculate how much tax to pay in. Another issue is that many taxpayers believe that estimated tax payments must be made Quarterly. This means that a realtor with sporadic commissions, is expected to hold a tax payment for an entire quarter and then make their estimated tax payment. By this time, they have paid current and past due bills from periods when they did not have the cash to make those payments.
Investors don’t really know how much gain or loss they will ultimately have at year end. This makes it impossible to estimate tax payments. If there is a huge gain, then their tax bill is higher than expected and they have not paid in enough during the year. Yes, this sucks all the way around.
Taxpayers must generally pay at least 90% of their income tax during the year to avoid penalty. W-2 employees find themselves owing under payment penalties as well if their withholding is not sufficient to cover at least 90% of their tax bill. You can make estimated tax payments or you can simply increase your withholding.
5 ways to know if you should be making estimated tax payments:
How do I know how much to pay? I advise commission based taxpayers to determine their tax rate. When they receive their commission, Multiply their commission x tax rate. Make an estimated tax payment for this amount every time they receive their commission. Do not pay monthly or quarterly. Pay when the money comes in. This is a game changer and keeps you on the right side of penalties.
When do I pay? For certain taxpayers, I advise making estimated tax payments each time income is received. However, estimated tax payments should be made at least quarterly on 4/15, 6/15,9/15 and 1/15. You can make estimated tax payments online at IRS.gov.
Making estimated tax payments is a great way to avoid incurring additional tax liability. Think about where you may land at year end with your tax liability. Do you need to make estimated tax payments? Now is the time to determine this or hire a CPA for tax planning.
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