Estimated Taxes and the Estimated Tax Penalty

Calculating How Much Estimated Tax to Pay

Calculator and bank account
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Paying estimated taxes is one way for individuals to remit payments for their taxes to the federal government. Generally, people who have incomes that aren't subject to tax withholding at the source of payment should consider making estimated payments. Types of income without withholding including business income, rental income, investment income and capital gains. Taxpayers who have withholding on their wages or pensions can consider increasing the amount of tax withheld to cover the tax on their other sources of income.

The Estimated Tax Penalty

As a general recommendation, taxpayers should consider prepaying tax through estimated tax payments so as to avoid the penalty for the underpayment of estimated taxes. To avoid the penalty, individuals will need to pay in "at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller," Tax Topic 306,

The estimated tax penalty is essentially a charge for interest for not paying taxes throughout the year. The current interest rate for underpayments by individuals is 3%. (The IRS sets this rate each quarter.)

Figuring out how much to pay in estimated taxes

The easiest method for calculating estimated payments is to divide last year's unfunded tax liability in four, and then make estimated payments using this figure. To do this, look on last year's tax return and find your total tax liability. Then subtract any withholding you expect to pay in for this year.

If your withholding will be about the same as last year, you could subtract last year's withholding amount. The difference is the amount of tax that needs to be paid in through estimated taxes.

This method, while quick and easy to calculate, does not take into account changes in your income or changes in your deductions for the current year.

You might have more income, or less income, or qualify for different tax deductions. The alternate method is to project a tax calculation based on this year's income. For this, it's helpful to use the worksheets found in Publication 505 and with Form 1040-ES.

What I do is run a report showing income and deductions for the year using a financial software program. Financial software can generate a report showing income and deductions for the year-to-date (or any other time period you want to measure). I then export the figures into a spreadsheet program for further number crunching. Be sure to multiply these year-to-date amounts to cover the entire year. To make the math easier, you may want to run the report based on, the first half of the year, for example, and then you could multiply by two to get a projected full year figures.

Using these annualized income and deduction figures, you will calculate your projected tax liability. You will need to know the current year's tax rates. And you would subtract any withholding or tax credits you will be eligible for in order to find out exactly how much needs to be paid in through estimated tax payments.

To help keep track of these tax calculations, the IRS has a worksheet available with Form 1040-ES (pdf). This worksheet will help you calculate the minimum amount of estimated tax you should pay to avoid the penalty. The worksheet also includes all of the current year figures for standard deductions and tax rates, to help you obtain an accurate figure for this year's estimated payments. (Here's a sample estimated tax calculation so you can see the sort of math involved.)

After setting up your own spreadsheet, be sure to save it for future reference. Once the spreadsheet is set up, you can use it again to get a more accurate projection of your tax liability later in the year. And then you will be able to adjust your estimated payments so you pay in just the right amount.

Estimated tax payments are due quarterly. Here's a list of the payment due dates.

Figuring out how much estimated tax to pay is the hard part. Once you have your payment amount, you can send in estimated payments by check, pay by credit card, or use the Treasury Department's online bill payment system.


Paying Estimated Taxes by Check

Paying estimated taxes by check is pretty easy. Just make sure to use the 1040-ES payment vouchers (pdf). Make the check payable to the "United States Treasury." In the memo field of the check, be sure to write your Social Security Number and indicate the year for which you are paying, for example "2014 Form 1040-ES."

Avoid making the check payable to the "IRS" or "I.R.S." as some thieves have confiscated these checks and altered the name to "J.R.Smith" or "MRS Smith" or some other permutation. You can prevent this sort of theft by always writing out "United States Treasury," as that cannot be easily altered.

Mail your check along with a Form 1040-ES voucher to the IRS. Current mailing addresses for estimated tax payments are located at: Where to File Addresses for Taxpayers Filing Form 1040-ES.

Paying Estimated Taxes by Credit Card

To pay by credit card, you'll need to use an authorized third-party payment service. These payment services process tax payments by credit card or debit card and forward the funds to the Internal Revenue Service. The payment processing services charge convenience fees.

Paying by credit card is very convenient, but I usually don't recommend it because there's a convenience fee involved, and you'll have to pay any finance charges on top of that.

Still, paying by credit card can help avoid any late payment penalties charged by the IRS.

Paying Estimated Taxes by Online Bill Pay

The Treasury Department operates two online payment systems. One is called the Electronic Federal Tax Payment System, or EFTPS for short. I use EFTPS personally, and the service works very smoothly.

It can take a few weeks to get fully registered with the service. Once you are set up, you will be able to schedule estimated payments from your checking account very quickly. EFTPS users can print out a report showing all their estimated payments for the year, which is a handy report to have at tax time. To pay your estimated taxes, simply login to EFTPS and schedule an estimated payment. You can indicate the dollar amount and the date you want the payment withdrawn from your bank account.

The second online payment system is Direct Pay. This system is accessed from the Web site. Direct Pay is designed to handle payments of personal income tax only. The service does not require registration, and so people can use Direct Pay straightaway (unlike EFTPS, which requires a wait time to get fully set up on the service).

Both EFTPS and Direct Pay enables people to schedule federal tax payments from a checking or savings account.

Estimated Tax Deadlines

Estimated tax payments are due quarterly on the following days:
  • April 15th,
  • June 15th,
  • September 15th, and
  • January 15th.
Some taxpayers pay more frequently than this. Some people have set up the monthly payments by EFTPS so that a fixed amount of tax is paid as part of their monthly budget. And if you skip a payment, you may want to adjust your subsequent estimated payment to cover the shortfall.

Here's an example of a estimated tax projection for an independent contractor. To run this projection for yourself, you'll need to know your income and deductions for the year so far, and then develop a little spreadsheet to multiply those figures into an annual amount.


Sample Estimated Tax Calculation

Shelley is an independent contractor, which is her sole source of income. For the first three months of the year, she had $25,000 of self-employment income and $7,500 of business expenses, resulting in a net profit of $17,500.

Her business isn't very seasonal, so it would be a safe assumption that her income and expenses for the next nine months of the year will be similar. To project her income for the year, we need to multiply her income by a ratio. Since we have income for first three months of the year, this income represents 3/12ths or one-fourth of her annual income. To project her income for the full year, we need to multiply by the inverse or reciprocal ratio. The reciprocal of 3/12ths is 12/3rds, which is the same as saying that the reciprocal of one-fourth is four. Multiplying our year-to-date figures by the reciprocal results in an income amount that is projected to be 100% of the full year. Multiplying Shelley's net profits of $17,500 (for the first three months) by the reciprocal ratio (12/3rds), we find that $70,000 is what we expect Shelley's net profit for the full year to be.

Now that we've found a full year's worth of net profit, we can begin a tax calculation.

Shelley's business income for the year will be about $70,000. As an independent contractor, Shelley's income will be subject to both the income tax and the self-employment tax. So here's how the tax calculations would work:

Self-employment tax ($70,000 x 0.9235 x 15.3%) = 9,890.69
Deduction for half of the self-employment tax = 4,945.34
Standard deduction for a single person = 6,100
Personal exemption for herself = 3,900
Taxable income (70,000 - 4,945 - 6,100 - 3,900) = 50,055

Now that we've found Shelley's taxable income for the year, we can calculate her income tax using the 2014 tax rates for this example. Using the tax rate schedule for a single person, we calculate the federal income tax as follows:

Example: Shelley, Single Filing Status
If taxable Income is:abcde
OverBut not overTaxable incomeMultiplication amountMultiply (a) by (b)Subtraction amountSubtract (d) from (c). This is the federal income tax.
36,90089,350$50,055× 0.25$12,513.754,143.75$8,370.00


As a single person, Shelley's income tax is estimated to be $8,370. This plus her self-employment tax of $9,890.69 equals how much she needs to pay in this year: $18,260.69, or $18,261 after rounding. In order to avoid the estimated tax penalty, Shelley would need to pay in at least 90% of this amount. However, Shelley might also want to pay the full amount of the tax to prevent from owing at tax time. If she wanted to pay in 90% of her current tax, Shelley would take the tax amount, multiply by 90%, and then divide by four to find each of her four estimated payments, or about $4,109 each.

If Shelley wanted to pay 100% of her tax, we would take the tax amount and divide by four to find each of her four estimated payments, or about $4,565 each.

I recommend saving all your calculations in a spreadsheet program. That way, you'll be able to run new calculations at different times of the year and adjust your estimated payments accordingly. This is especially helpful for people with seasonal income. And the spreadsheet can be further used as a planning tool to see how much savings can be achieved through various tax deductions and credits.

You can adjust your withholding on your paycheck to cover any additional taxes from other income such as interest, dividends, and income from side jobs or consulting work. In fact, this is a question I am frequently asked.

Nancy, a regular About Taxes reader, emailed me to ask:

"I searched the IRS website on info about extra withholdings but can't seem to find an answer. I just took a second job where I'm being paid as a 1099 vendor. Can I have extra federal and state tax withheld from my payroll with my primary employer to be paid in safe for [the year]? Or do I need to file and pay quarterly with the IRS? There isn't an option on our payroll to have extra social security withheld so I wasn't sure if it's okay to wait until I file my ... return to pay that."
Individuals can always adjust their income tax withholding to cover the additional taxes for a freelance job or other income they have. Simply fill out a new Form W-4 and give it to your employer.

There's a couple different ways that we could adjust the withholding figures. One is to adjust the number of withholding allowances. The other is to indicate an additional dollar amount to withhold each paycheck. To use either method you will first need an idea of how much extra taxes you'll be responsible for. Let's suppose that the income tax and self-employment tax on Nancy's second job will be $4,000 for the year.

Let's take the second method first. Nancy could take this tax amount and divide it by the number of remaining pay periods in the year. This results in an additional of tax that she could withhold. On Form W-4, this amount would be put on Line 6 as an additional amount to withhold. This additional tax will show up on her W-2 as part of her federal income tax withholding.

That withholding will show up as a payment on her tax return for the year, and will be applied to her total tax for the year, including any self-employment tax.

The first method is to adjust the number of withholding allowances. To do this, Nancy would need to reduce the number of withholding allowances such that her federal withholding will increase by an amount sufficient to cover the additional tax she's expecting.

This often involves trying different withholding allowances using a withholding calculator.

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