How to Get Ahead on Tax Payments for Next Year
The IRS expects you to pay as you go, even with unemployment benefits
The U.S. federal tax system is a pay-as-you-go arrangement. Taxpayers are supposed to pay the IRS its share of their earnings relatively soon after they receive any income. Ideally, you’ll pay toward your tax obligation throughout 2020 by one means or another, but this can be challenging enough under normal circumstances, especially for the self-employed.
Throw in a pandemic and record unemployment rates and you could easily find yourself facing a formidable, unexpected tax bill next spring when it’s time to file 2020 taxes—especially if you received unemployment benefits. Or perhaps this bumpy year caused you to forget to make an estimated payment. Whatever the case, it’s not too late to salvage the situation.
Adjust Your Withholding
Taxpayers who work for employers and who were able to continue to do so during the pandemic might fare better than others when it comes time to file that tax return by April 2021. They already have paid as they earned because taxes are withheld from each of their paychecks based on information they provided to their employers on their Form W-4. Their employers have been forwarding that money to the IRS on their behalf all along.
Your withholding should come pretty close to covering what you’ll owe if you completed your Form W-4 correctly and if you didn’t have any additional sources of income that you haven’t accounted for on the form.
But Form W-4 can be changed as needed. The IRS recommends reviewing and updating it from time to time to ensure that the information you initially provided to your employer is still correct. This includes your filing status, the number of your dependents, and any tax credits you’re likely to claim—or that you won’t be able to claim again this year.
You can request that more money be withheld from your pay to cover the extra income from a side gig that’s been generating some much-needed cash during difficult times—there’s a special line on the 2020 Form W-4 for this purpose. And you should definitely update your withholding if you married, divorced, had a child, or had a child “age out” of dependent status at any time in 2020.
The IRS provides a handy tax withholding estimator on its website to help you get your withholding just right.
Make Estimated Quarterly Payments
Those who are their own bosses or who prefer to leave their employers out of the process rather than request extra withholding can make estimated quarterly income tax payments. These payments are based on what someone thinks they’ll probably owe on all taxable income at year’s end.
IRS Form 1040-ES includes a worksheet to help you make an accurate prediction of what you’re likely to owe.
Sole proprietors and independent contractors must make estimated payments because their clients and customers don’t typically withhold taxes from their payments to them. The IRS charges penalties if they don’t do this and come up short at filing time. But other taxpayers are free to pay in this way as well.
The key to avoiding an estimated tax penalty is to pay at least 90% of your total tax bill by year’s end if you suspect that you’ll owe the IRS $1,000 or more in income tax for the year.
The “quarterly” part of this option derives from the fact that estimated payments are due to the IRS four times a year. But there are only two left for tax year 2020.
“If you know your tax bracket, you can send a quarterly payment on Sept. 15, 2020, for the third quarter, and Jan. 15, 2021, for the fourth quarter,” Michael Merlino, president and CEO of Atlantic Accounting Services in Northfield, N.J., told The Balance in a phone interview.
The other quarterly payments are typically due on April 15 and June 15, but were pushed back to July 15 in 2020 in response to the coronavirus pandemic. As of September 2020, the first three deadlines for 2021 should be April 15, June 15, and Sept. 15, based on customary procedure, although the IRS has not yet confirmed this.
Did You Collect Unemployment?
Of course, nothing has been simple in 2020. Many Americans who were out of work during the coronavirus pandemic—13.6 million of them as of August 2020—received a $600-per-week bump in their unemployment checks under the terms of the Coronavirus Aid, Relief, and Economic Security (CARES) Act through at least July 31, 2020.
Additionally, taxpayers who would not normally be eligible to collect unemployment, such as sole proprietors and independent contractors, could collect during this same period as well if they lost their jobs due to the pandemic.
However, these unemployment checks are taxable income. You must include any relief benefits received on your 2020 tax return.
“The $600 unemployment benefit as part of the stimulus package will cause a bit of a tax problem if you have other income in 2020,” Merlino said. “The problem is that in many cases, taxpayers have no way, outside of estimated tax payments, to withhold. There’s a remedy—the IRS offers a form to withhold on any unemployment income you receive from state sources, but you have to hand in your withholding request at a local tax office and few state tax offices are open.”
You can expect to receive a Form 1099-G detailing how much you received in the way of unemployment benefits and how much you had withheld for taxes, if you were able to arrange for withholding. Unfortunately, you’ll get the form after the close of the 2020 tax year, and that doesn’t leave you a lot of time to catch up if you’re short. You have until Jan. 15, 2021, to make estimated tax payments to cover as much of this income as possible without incurring a penalty.
The IRS offers an interactive tool on its website to help you determine whether your unemployment benefits are taxable, but you should know that they typically are.
Did You Get a Stimulus Check?
The good news here is that the stimulus check provided by the federal government to help many Americans during the 2020 coronavirus economic crisis is not taxable income. Officially called the “Economic Impact Payment” (EIP), you might even have a little extra coming to you if the check you received was less than you think you qualified for because you didn’t receive payment for one or more of your children. The IRS indicated in August that it would be issuing “catch-up payments” to correct these errors, hopefully by mid-October.
The EIP is technically an advance on a one-time (so far) refundable tax credit for the 2020 tax year. The IRS distributed the checks rather than make you wait until you file your 2020 tax return in the 2021 filing season to claim the money. You can claim any extra you think you might be entitled to as a tax credit on your 2020 return, for reasons such as not receiving an extra $500 for your dependent child.
The IRS is expected to confirm the proper procedure making this request later in 2020. Information and instructions are also available on the IRS Notice 1444.
The Bottom Line
It’s been an unusual year that may have affected the amount of your income and how you earn that money. So it’s important to make sure as soon as possible in 2020 that you have estimated how much you’ll be taxed on, including any unemployment payments received.
You have some options to catch up on what will be owed to the IRS next April, including two more rounds of estimated quarterly payments and employer withholding.
Internal Revenue Service. "Pay As You Go, So You Won’t Owe: A Guide to Withholding, Estimated Taxes, and Ways to Avoid the Estimated Tax Penalty." Accessed Sept. 18, 2020.
Internal Revenue Service. "Estimated Taxes." Accessed Sept. 18, 2020.
Internal Revenue Service. "Filing and Payment Deadline Extended to July 15, 2020 - Updated Statement." Accessed Sept. 18, 2020.
Bureau of Labor Statistics. "The Unemployment Situation—August 2020." Page 1. Accessed Sept. 18, 2020.
U.S. Congress."H.R. 748 - CARES Act." Accessed Sept. 18, 2020.
Internal Revenue Service. "Economic Impact Payment Information Center: Reconciling on Your 2020 Tax Return." Accessed Sept. 18, 2020.