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How to Calculate Estimated Taxes

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If you’ve ever taken a look at your paycheck, you’ve probably noticed that your employer withholds a percentage of your money every month for taxes. But what about if you’re self-employed or own your own business? If you don’t have an employer withholding tax from your earnings, you need to schedule quarterly payments to make up the difference. If you don’t, you may put yourself at risk of invoking IRS fees and penalties. Before you file your taxes this April, get a grip on your finances and figure out how much you need to be paying quarterly in 2019.

Who Needs to File Quarterly Taxes?

Most salaried and hourly employees do not need to make estimated tax payments because taxes are automatically deducted from their paychecks. If any of the following circumstances apply to you, you will probably have to make quarterly payments:

  • You’re self-employed, operate as an independent contractor or own a business. If you made over $600 worth of income last year and did not have tax payments withheld by an employer, you need to make scheduled payments.
  • You owe back taxes. If you owe back taxes from last year’s tax season, you are required to make quarterly tax payments to absolve your debt and assure the IRS that you’ll be able to cover anything outstanding you owe for this year.
  • You made over $600 from rental properties or stock dividends last year. If you own rental properties or dividend-producing stocks, you may have to make estimated quarterly payments on this income — even if you already have taxes withheld from a salaried or hourly job.

Still aren’t sure if you need to make quarterly payments? You can use the IRS’s interactive tax assistant service for a more personalized answer.

Why Do I Need to File Quarterly Taxes?

The government knows that most taxpayers are pretty bad at budgeting their money. Many people spend their entire paycheck as soon as they get it and build up credit card debt to cover the rest of their expenses throughout the month. According to data from the Federal Reserve’s Annual Report on the Economic Well-Being of U.S. Households, a whopping 40 percent of Americans do not have enough money in savings to cover a $400 emergency bill. Throw in America’s credit card debt and student loan debt statistics and you can see why most consumers aren’t lining up to pay their taxes.

Source: https://www.lexingtonlaw.com/blog/loans/credit-card-debt-statistics.html

Rather than risk waiting until tax season and hoping that consumers have saved enough money to cover their tax liability, the government requires employers to withhold a percentage of every employee’s income to cover their Social Security, Medicare, and federal tax contributions. The federal government actually encourages people to overpay on their taxes throughout the year, which is why most regular employees are given a tax refund after they’ve filed; your tax refund essentially represents an interest-free loan you gave to the government.

When you’re self-employed or operating as an independent contractor, you don’t have an employer to withhold your taxes for you. This means that you are required to understand the income taxes and self-employment taxes you owe and make estimated payments similar to the payments that are automatically deducted from an employee’s paycheck. Thinking about throwing your estimated payments to the wind and dealing with everything when April rolls around? Don’t. The IRS employs strict penalties when you willfully neglect to pay your quarterly taxes.

You may be subject to up to a 5 percent penalty for each day that your estimated tax remains unpaid, and the IRS may issue you a penalty even if you are scheduled to receive a refund. Though the IRS may give you a break on estimated payments if you are over the age of 62, are retired, or you live in an area that’s been victimized by a natural disaster, you should do everything in your power to make accurate and timely estimated payments.

When Are Quarterly Taxes Due?

As their name suggests, quarterly payments need to be made four times a year. The deadlines for quarterly payments are as follows:

  • For any money made between January 1 and March 31: April 15
  • For any money made between April 1 and May 31: June 17
  • For any money made between June 1 and August 31: September 16
  • For any money made between September 1 and December 31: January 15 of the following year

Note that these dates don’t follow a standard quarterly schedule. Set these dates as reminders in your calendar to make sure that you pay on time and avoid account overdraft fees for scheduled payments.

How to Calculate Estimated Quarterly Tax Payments

Use the following steps and examples to calculate how much you should be paying every quarter.

Step 1: Figure Out the Taxable Income You Made Last Year

You can use the amount of money you made last year as a guide to figure out how much you should be paying in quarterly taxes. Unfortunately, it’s possible to underestimate exactly how much money you made last year and end up inadvertently underpaying on your taxes. To find out how much money you made, gather your bank statements and Form 1099s and calculate exactly how much taxable income you made; this number is your gross taxable income.

Taxable income does not include streams of income that are protected, like child support payments, qualified scholarships, interest gained from municipal bonds or gifts worth less than $14,000. As an example, let’s say that you had three clients issue you 1099 forms: one valued at $30,000, one valued at $40,000, and one valued at $20,000. You would add these three numbers up to find your total gross taxable income — in this example, $90,000.

Step 2: Subtract Your Above-the-Line Deductions and Your Standard Deduction

The IRS allows you to subtract certain “above-the-line” deductions from your income, along with the standard deduction. For 2019, the standard deduction for single filers is $12,000 and $24,000 for married couples filing jointly. This means that you can automatically deduct the standard deduction from your gross income, no questions asked. Above-the-line deductions also reduce the amount of income that you need to pay. Some of the most commonly applied above-the-line deductions include:

  • Contributions to traditional IRAs
  • Alimony payments
  • Half of your self-employment tax
  • Certain higher education expenses
  • Moving expenses you incur after taking a job out-of-town
  • Regular and “non-lavish” expenses incurred while traveling for business

In this example, let’s say that you had $30,000 in above-the-line deductions. You would subtract $30,000 from your taxable income ($90,000) and then subtract the standard deduction ($12,000 for single filers in 2019). These deductions would you with $48,000 of income that you must pay taxes on.

Step 3: Locate Your Tax Brackets

The IRS uses a graduated tax system, which means if you made more money, you are required to pay a larger percentage of your income. Before you begin filing taxes, you’ll need to find your corresponding federal tax bracket using your adjusted taxable income found in step two. Federal tax rates for this year are as follows:

Source: https://www.hrblock.com/tax-center/irs/tax-brackets-and-rates/what-are-the-tax-brackets/

Use this chart to complete step 4.

Step 4: Calculate What You Owe in Federal Income Tax

If your income is between $38,700 and $82,500, you might assume that you just need to multiply your taxable income by 22 percent to find what you owe in federal taxes. Luckily, this is not the case — you’ll only have to pay 22 percent on income earned above the lower end of the 22 percent bracket. In the current example, you have $48,000 worth of taxable income.

This means that you will have to pay 10 percent on your income up to $9,525, 12 percent on the next $29,175 ($9,525 to $38,700) and 22 percent on the remaining $9,300. After you’ve found the percentages, just add them up to find what you owe in federal income taxes. $9,525 x 0.10 = $952.5 $29,175 x 0.12 = $3,501 $9,300 x 0.22 = $2,046. $952.50 + $3,501 + $2,046 = $6,499.50, which is the amount that you would owe total in federal taxes.

Step 5: Calculate What You Owe in Self-Employment Tax

Next, calculate how much you owe in self-employment tax. The self-employment tax rate for this year is 15.3 percent. Multiply your total taxable income by 0.153 to find out how much you owe in self-employment tax. In the current example, you would multiply $48,000 by 0.153 and find that you owe $7,344 in self-employment tax.

Step 6: Add it All Together and Divide by Four

To calculate your total tax liability for the year, add your self-employment tax dues to your income tax dues. $7,344 + $6,499.50 = $13,843.50, which would be the total amount that you owe in federal taxes. To find out how much you should be paying each quarter, simply divide that number by four. In this example, you should be paying about $3,460.88 on each of the four payment due dates listed at the beginning of the article.

Final Thoughts

Attempting to figure out how much you owe in quarterly taxes on your own can be a massive headache. If you are self-employed or own a small business, you should strongly consider investing in tax software for the self-employed. Tax software does more than help you schedule payments and get everything in order during tax season — it can also help you organize your receipts, catalog miles you’ve spent traveling, and make sure that you’re taking advantage of every possible deduction and credit.

Even if you chose not to use tax software, you should take careful note of every dollar you spend running your business. A stray $5 for a pack of stamps or a stack of notebooks might not seem like much but these expenses can really add up when it comes time to calculate your deductions.