Estimated tax is a form of tax prepayment levied on income that does not have tax withheld at source. This is the case, for example, for self-employed professionals, independent contractors, investors, rental property owners, among others.
Who has to pay the estimated tax?
Individuals who receive income not subject to withholding and who owe at least $1,000 in federal income tax for the year, after subtracting any tax credits withheld at source, are required to pay estimated tax.
This includes:
- Self-employed individuals and independent contractors;
- Investors who receive dividends, interest or capital gains;
- Writers who receive royalties;
- Landlords who earn rental income;
- People who receive taxable unemployment compensation or retirement benefits;
- Anyone with income that does not have tax automatically withheld.
In addition, corporations (including S Corporations and partnerships) must pay estimated taxes if they expect to have a tax liability of $500 or more.
Payment Schedule the Estimated Tax
Estimated taxes must be paid in four installments throughout the fiscal year:
- 1st installment: April 15
- 2nd installment: June 15
- 3rd installment: September 15
- 4th installment: January 15 of the following year
Important: the fiscal year is divided unevenly for estimated tax purposes:
- 1st quarter: January 1 to March 31
- 2nd quarter: April 1 to May 31
- 3rd quarter: June 1 to August 31
- 4th quarter: September 1 to December 31
Calculating Estimated Tax
The form used to calculate estimated tax is IRS Form 1040-ES. Taxpayers must estimate their annual income, deductions and credits, and then calculate the tax due. It is recommended that estimated payments equal at least:
- 90% of the current year’s tax liability; or
- 100% of the previous year’s liability (or 110% if adjusted gross income was over $150,000).
If payments do not meet this minimum, the taxpayer may be subject to interest and penalties.
Exemption from Payment
You are not required to pay estimated tax if:
- You had no tax liability in the previous year;
- You were not a U.S. citizen or resident for the entire year;
- Your net income was less than $400.
Employees with parallel activity
If you have a salaried job and also a parallel activity as a self-employed person, you can adjust the amount withheld by your employer from your paycheck to cover your total tax liability, thus avoiding the need to pay estimated tax separately.
Natural disasters and extensions
The IRS often grants extensions for payment of estimated taxes in cases of natural disasters such as hurricanes, floods or forest fires. You can consult the official IRS press releases to check your eligibility for an extension.
Conclusion
Paying your estimated tax is essential for staying up to date with the IRS and avoiding fines. Understanding the calendar and applicable rules helps you better plan your cash flow throughout the year.
If you have any doubts about your obligation to pay estimated taxes or how to calculate the correct amounts, consult an accountant or professional specializing in US taxes.
Written by Marcos Ferreira, Content Analyst at Drummond Advisors, and Rodrigo Siracusa, Team Leader Accounting US at Drummond Advisors