Taxation

Estimated Taxes for Individual Taxpayers

Except for some very limited cases, such as for some retirees on low, fixed incomes, if you make money, or "earn income," as the IRS would say, then you have to pay federal income taxes.

Generally, the taxes are due as you earn the income. So, throughout the year, most Americans owe taxes each time we get a pay check or get paid interest from a checking account.

Exactly how those taxes are paid or collected, however, are quite different. There are two ways income taxes are paid:

  • Withholding taxes, where your employer keeps a portion of your wages to pay your income taxes
  • Estimated taxes, where you take full responsibility for paying the taxes

Withholding taxes are a prepayment of taxes, but going backward. For example, you may have paid taxes for 2010 throughout the year with each paycheck. By the April tax filing deadline, you've already paid most - if not all - the taxes you owed for last year.

Estimated taxes are prepaid as well, but you pay forward. The amount you pay is based on the income you expect to earn next year, in 2011 for example.

Usually, taxpayers have enough taxes withheld to cover any tax owed for a particular year. Estimated taxes kick in when you either don't have enough taxes withheld or no tax is withheld at all.

Who Must Pay Estimated Taxes?

Generally, for the tax year 2011, you have to pay estimated taxes if:

  • You expect to owe at least $1,000 in taxes for 2011, after you subtract the amount of any taxes withheld (if any) and the amount of any tax credits you may have, such as the credit for child and dependent care or the credit for disabled or handicapped persons and
  • You expect your withholding and credits to be less than the smaller of: (1) 90 percent of the tax you'd normally report on your 2011 tax return, or; (2) 100 percent of the tax shown on your full 12-month 2010 tax return

You don't have to pay estimated taxes for 2011 if:

  • You didn't owe taxes in 2010 - your total tax was $0 or you didn't have to file an income tax return, and
  • You were a U.S. citizen or permanent legal resident for all of 2010 and,
  • Your 2010 tax year covered a 12-month period

What Triggers Estimated Taxes?

A number of things may trigger the estimated tax. It's most common for the self-employed, like independent contractors. This is because taxes generally aren't withheld from payments for their services.

You may have to pay estimated taxes for other reasons when there's been no withholding of taxes and you get a straight payment of income. For instance, when you:

  • Earn income from investments, such as stock dividends
  • Get alimony payments
  • Win prizes or awards
  • Receive interest from your bank on a checking or savings account

Even taxes are withheld, you may still have to pay estimated taxes. A good example is when you don't have enough taxes withheld from your paychecks to cover all of the income taxes you owe for the year. In this case, you should use the IRS calculator to figure out how much tax should be withheld, complete a new W-4 Form, and ask your employer to withhold more tax.

Calculating & Paying Estimated Taxes

You can pay your estimated taxes all at once or you can pay in four installments during the next tax year. Basically, you'll pay your 2011 taxes starting as soon as you have income in 2011 and then into 2012. The installments are based on the calendar year. For income you receive in 2010 between:

  • January 1 through March 31, your payment is due April 18
  • April 1 through May 31, your payment is due June 15
  • June 1 through August 31, your payment is due September 15
  • September 1 through December 31, your payment is due January 17, 2012

The IRS provides you with payment vouchers so your installment payments are credited properly.

How much do you pay? Figuring out estimated tax payments can be complicated. The IRS has detailed instructions and worksheets to help. Generally, however, there are three options:

  • Current Year, which requires you figure out your expected adjusted gross income, taxable income, taxes owed, deductions and credits for 2011. Here, you'll pay 90 percent of your 2011 tax in four equal installment payments
  • Prior Year, where you pay 100 percent of the taxes you paid in 2010 in four equal installments
  • Annualization, where installments are based on your 2011 income you actually receive just weeks before each installment is due

Before deciding on which option is best for you, it's a good idea to talk to your tax adviser or tax lawyer.

Penalties

While you're not legally required to make estimated tax payments, the IRS can make you pay an addition to tax penalty if you're supposed to pay estimated taxes and don't pay at all or don't pay enough. Essentially, the penalty is the interest owed on the unpaid taxes.

Like other federal income taxes, you can also face criminal penalties for not paying estimated taxes.

Questions for Your Attorney

  • I earn 15 percent interest on my income that I'd have to pay estimated taxes on. If the IRS penalty is less than 15 percent, why shouldn't I skip paying estimated taxes and just pay the penalty?
  • I paid estimated taxes in 2009 and 2010, but with the recent economy, I'm not sure if my calculations are right for 2011. If I overpay, can I get a refund?
  • I'm a contractor and my income varies seasonally. Do my estimated tax payments have to be equal and is the payment process different for uneven payments?
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