If you’re an employee of a business, your employer withholds taxes from each paycheck and sends the money to the IRS, and likely your state government as well. This way, you pay income tax throughout the year.
However, if you are self-employed, or if you earn income from investments, you may need to pay estimated taxes each quarter to square your tax bill with Uncle Sam. You may owe estimated taxes if you receive income which isn’t subject to withholding, such as:
- Dividends & Interest Income
- Residential or Commercial Real Estate / Farm Land
- Gains from sales of stock or other assets
- Earnings from a business
- Taxable Alimony
Do You Need to Pay Estimated Taxes?
Determining if you need to pay estimated taxes depends on your situation. The rule is, you must pay your taxes as you go.
If at filing time, you have not paid enough income tax through withholding or quarterly estimated payments, you may have a penalty for underpayment.
To determine whether you need to make quarterly estimated payments, start by answering these three questions:
- Do you expect to owe less than $1,000 in taxes for the tax year after subtracting your federal income tax withholding from the total amount you expect to owe this year? If so, you are likley in the clear and you don’t need to make estimated tax payments.
- Do you expect your federal income tax withholding to amount to at least 90 percent of the total tax you will owe for this tax year? If so, you are likley in the clear and don’t need to make estimated tax payments.
- Do you expect your income tax withholding to be at least 100 percent of the total tax on your previous year’s return? Or, if your adjusted gross income (Form 1040, line 37) on your tax return was over $150,000 ($75,000 if you’re married and file separately), do you expect that your income tax withholding will be at least 110 percent of the total tax you owed for the previous year? If so, you’re likely in the clear!
If you answered “No” to these questions, you must make estimated tax payments using Form 1040-ES. To avoid a penalty, your total tax payments (estimated taxes plus withholding) during the year must satisfy one of the requirements above.
Which Option Should You Choose?
Every situation is different. The Buttonwood Team works with our clients and CPAs to determine the best option for your unique situation.
The safest option to avoid any underpayment penalties is to aim for “100 percent of your previous year’s taxes.” If your previous year’s adjusted gross income was more than $150,000 (or $75,000 for those who are married and filing separate returns), you will have to pay 110 percent of your previous year’s taxes to satisfy the “safe-harbor” requirement. If you satisfy either test, you won’t have to pay an estimated tax penalty, no matter how much you owe from your tax return.
So what if you expect your income to be less than last year? You may not want to pay more taxes than know you will owe. You can choose to pay 90 percent of your estimated current year tax bill. If the total of your estimated payments and withholding equals less than 90 percent of what you owe, you may face an underpayment penalty; so it’s best to give yourself a safety net.
How Can Buttonwood Assist with Quarterly Estimated Payments?
We will coordinate your estimated tax payments for you! Utilizing the Electronic Federal Tax Payment System (“EFTPS“), we can make one-time, monthly, quarterly, or year-end Federal tax payments on your behalf. The setup of this service consists of 3 simple steps. Contact us today to learn more about the setup process!
Once everything is in place, we will move funds from investment assets to your checking account, if necessary. Then, we will make your tax payment for you from your checking account! Each year, we work with our clients and their CPAs to obtain the correct current-year and quarterly estimated tax amounts. We are pleased to offer this service to our clients and are proud to simplify the complexities that come with taxes and overall financial wealth!
As Your Family CFO, coordination of taxes is just one part of what we do for our clients. Our comprehensive strategy and implementation focuses on tax, insurance, estate, investments, retirement, cash flows and business strategies. Explore the benefits of your very own Family CFO today! We look forward to the opportunity to simplify your financial life.