Everyone’s accustomed to paying taxes, even if many of us may only think about them once a year. But did you know that under certain circumstances, you could be required by the Internal Revenue Service (IRS) to pay estimated taxes throughout the year? Collected once a quarter, these quarterly taxes keep certain taxpayers on top of their yearly tax obligations. This is especially true for those who are considered self-employed and gig workers that don't have tax withholdings from their regular earnings and pay, but could also apply to anyone with a regular payroll paycheck that doesn't have enough tax withholdings. Below you'll learn more about the difference between annual taxes and quarterly taxes, as well as the impact they may have on your tax returns later.
Annual Taxes
Annual taxes are determined by the IRS based on your household income. Your tax obligation is then adjusted based on relevant deductions, credits, and exemptions you’ve qualified for. Typically, those who earn a salary or wages have a portion of their paycheck taken out each month and used to pay their tax obligation regularly throughout the year. Once a tax return is filed during tax season, that person pays the final amount owed to the IRS or receives a refund if they’ve overpaid throughout the year.
Quarterly Taxes
If you do not have a portion of your paycheck automatically deducted to pay down your tax obligation throughout the year, you may be required to pay estimated taxes quarterly. Alternatively, you may have a portion of your paycheck or pension withheld for taxes, but it is still not enough to cover your tax obligations for the year. Estimated tax is used instead of or in addition to annual taxes in order to pay your income tax, as well as other taxes such as self-employment tax and alternative minimum tax.1
When Are Quarterly Taxes Typically Required?
As mentioned above, estimated taxes may be required if the withholdings from your paycheck or pension are not enough. In addition, you may be required to pay estimated taxes if you’ve received additional income such as:
- Interest
- Dividends
- Alimony
- Self-employment income
- Capital gains
- Prizes
- Awards1
Who Pays Quarterly Taxes?
Individuals who are expected to owe $1,000 or more when their return is filed are typically required to pay estimated taxes quarterly. This tends to be business owners and self-employed entrepreneurs, including sole proprietors, partners and S corporation shareholders, according to the IRS.1
Technically, failure to pay a certain minimum amount of taxes throughout the year, prior to filing a tax return, could result in a penalty. To avoid a penalty, taxpayers must generally pay the lesser or 100% of the previous year's tax obligation or at least 90% of the current year's tax obligation. If the adjusted gross income (AGI) exceeded $150,000 during the previous year, then then the taxpayer must pay the lesser of 110% of the previous year's tax obligation or 90% of the current year's tax obligation. Typically the penalty for underpayment of taxes during the year is 5% of the unpaid amount, and capped at 25% of the total tax obligation. Underpaid taxes also accrue interest that is added to the tax obligation and penalty amount.
Just as they sound, quarterly taxes are due at the end of each quarter and paid by the 15th (or following business day if the 15th falls on a weekend or holiday) in April, June, September, and January. While you must pay a pre-determined amount by the end of each quarter, you can make payments weekly, monthly, or however often is needed to pay down the amount.
Penalties for Underpaid Taxes
Technically, failure to pay a certain minimum amount of income tax throughout the year, prior to filing an annual tax return, could result in a penalty. To avoid a penalty, taxpayers must generally pay the lesser or 100% of the previous year's tax obligation or at least 90% of the current year's tax obligation. If the adjusted gross income (AGI) exceeded $150,000 during the previous year, then the taxpayer must pay the lesser of 110% of the previous year's tax obligation or 90% of the current year's tax obligation. Typically the penalty for underpayment of taxes during the year is 5% of the unpaid amount, and capped at 25% of the total tax obligation. Underpaid taxes also accrue interest that is added to the tax obligation and penalty amount.
How Do I Know if Enough Income Tax is Being Withheld?
As part of its ongoing comprehensive financial planning service, Escient Financial can help you determine if enough income tax is being withheld from your paychecks. Your CPA or tax preparer can also help determine this. The IRS also offers their own Tax Withholding Estimator, which they recommend using at the beginning of the year, especially if you’ve recently experienced a major life event - marriage, birth of a child, bought a home, etc.2 This tool allows individuals and couples to determine how much they could be required to owe when filing their tax return.
According to the IRS, you are not required to pay quarterly taxes if you meet all three of the following criteria:
- There was no tax liability for the previous year,
- You’ve been a U.S. citizen or resident for the entire year, AND
- Your previous tax year covered an entire 12-month period1
What if Enough Income Tax Isn't Being Withheld?
If you're sure or if you suspect not enough income tax is being withheld from your paycheck, you can ask your employer to withhold more money if you want to avoid having to pay quarterly taxes. This is done by submitting a new W-4 to your employer for Federal taxes and for California workers by submitting form DE-4 for California State taxes.
If you don't change your tax withholdings, then it's a good idea to try calculating what you tax obligation for the year is likely to be and then subtract the projected total withholdings, and pay the remainder throughout the year as quarterly tax payments.
How you pay your taxes throughout the year can impact your tax return come filing season. In certain circumstances, paying estimated taxes quarterly can even prevent you from being hit with a penalty from the IRS. Work with your trusted tax professional and your financial planner to be sure you’re withholding the ideal amount from your paychecks, reducing your tax obligations in a productive way, and avoiding potential penalties or big bills during tax season. If you need help with any of this, feel free to...
This content is developed from sources believed to be providing accurate information. The information in this material is not intended as investment, tax, or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Digital assets and cryptocurrencies are highly volatile and could present an increased risk to an investors portfolio. The future of digital assets and cryptocurrencies is uncertain and highly speculative and should be considered only by investors willing and able to take on the risk and potentially endure substantial loss. Nothing in this content is to be considered advice to purchase or invest in digital assets or cryptocurrencies.
Enjoying Escient Financial’s Insights?
Escient Financial does NOT sell subscriber information. Your name, email address, and phone number will be kept private.
