Estimated Quarterly Taxes Explained

Aren't my taxes calculated when I file my tax return?

The IRS and States does not want to wait until you file your taxes to receive their tax money.

They want to receive their tax payments quarterly. For taxpayers who are employees, this is done by your employer. Taxes are withheld from your W2 and submitted to the IRS and States every quarter.

However, when you have income where there are no taxes withheld or you have a history of underwithholding, that doesn't work for the IRS and States. They still want their taxes every quarter and are going to penalize you and charge you more if you don't pay.

These penalties and interest can be avoided by paying estimated quarterly taxes.

If you are new to the process, we are going to simplify who needs to pay estimated quarterly taxes, what they are, why they're required, how to pay them, and when they are due.

Who Needs to Pay Estimated Quarterly Taxes?

Estimated quarterly taxes are primarily for individuals who receive income that is not subject to tax withholding. This includes:

Self-employed individuals
Freelancers
Independent contractors
Small business owners
Individuals with significant investment income
Recipients of alimony, rent, or dividends

If you expect to owe $1,000 or more in taxes for the year, after subtracting tax withholding and refundable credits, you either need to adjust your current withholdings or you will likely need to pay estimated quarterly taxes.

Sometimes you are good on withholdings for the IRS, but not at the state level. For example, if your pension withholds federal taxes but does not withhold state taxes for the state you currently live in, you may only have estimated quarterly payments to your state.

* Note that your business entity may also have estimated quarterly taxes if it has state franchise taxes that exceed the annual minimum.

What Are Estimated Quarterly Taxes?

Estimated quarterly taxes are advance payments of your income tax you expect to owe at the end of the tax year.

They are prepayments. So you are paying quarterly for the current tax year.

For example, your Q2 - June 15, 2024 payment is for your 2024 tax year.

Unlike employees, whose taxes are withheld from their paychecks, self-employed individuals and those with other sources of income must make these payments throughout the year directly to the IRS and/or their states to avoid penalties and interest.

Why Are Estimated Quarterly Taxes Required?

The IRS does not like to wait until March, April, July, etc of the following year when you file your tax return to collect its tax revenue.

They expect income to inflow all year and don't want to act as your creditor or bank.

The IRS is the last establishment you want to be your creditor.

If you are self-employed and living off of 100% of your net income, you are in-effect taking a loan from the IRS and your state every month. As they see a percentage of that net income being owed to them, and not truly yours.

What happens if you don't pay quarterly? When you file your tax return, you'll pay the IRS and your state EXTRA! Failure to make these payments can result in penalties and interest charges.

Being proactive and on top of your tax payments can save you thousands in interest and late payment penalties, just by paying your taxes periodically throughout the year...as you earn the income!

How to Calculate Estimated Quarterly Taxes

If you are working with a tax professional, they likely included a schedule of estimated quarterly payments to you to pay along with vouchers.

These estimates are most likely based on what you made and reported on your tax return from the prior year, assuming you make the same thing next year. They can be modified by tax professionals if you are aware of changes in your income and expenses and you provide that detail to your tax advisor.

In fact, for business owners, we recommend meeting with your tax advisor multiple times a year to update your numbers and refresh your calculations.

If you are going at it on your own, a simplified way to do this is to look at your effective tax rate from your prior year tax return. Apply that rate to your net income (sales - deductible expenses) and make a payment based on what you anticipate owing for that quarter's profits.

Knowing your numbers plays a key role in being on top of this. If you have a business and your books aren't up to date, you won't have numbers to base these decisions on.

How do you make your payments?

You can always mail in a voucher, but expect processing delays. If you choose this route, ALWAYS, make a copy of the check prior to mailing it in.

The best way is to simply pay online. You can login to the IRS website or State website and submit your payment. You will need your tax ID and some general information to do so, but it can take a few minutes and then you receive an email confirmation of your payment.

When Are Estimated Quarterly Taxes Due?

IRS estimated tax payments are due four times a year:

April 15: For income earned from January 1 to March 31
June 15: For income earned from April 1 to May 31
September 15: For income earned from June 1 to August 31
January 15 (of the following year): For income earned from September 1 to December 31

If these dates fall on a weekend or holiday, the due date is the next business day. It's important to mark these dates on your calendar to avoid late payment penalties.

If you pay the IRS, your annual amount due is split evenly, 25% across each quarter.

If you are in California, they complicate it. They use a different percentage every quarter, and you skip Q3.

Why is this done? If you are a conspiracy theorist, you may argue it's to trick the taxpayer. It only makes sense to California.

In California, estimated tax payments are due three times a year:

April 15: 30% of your annual tax due
June 15: 40% of your annual tax due
September 15: NO PAYMENT
January 15 (of the following year): 30% of your annual tax due

California payments can be made on the Franchise Tax Board website.

If you owe estimated taxes in another state, it will have it's own payment calculation and schedule.

What if I have seasonal income or one thing that causes a large inflow of income?

If you are a realtor, for instance, your cash flow comes in waves. How do you handle your payments?

We recommend making estimated payments quarterly or as your commissions come in.

You may have large payments in Q2 an Q3 when your summer commissions arrive, and then no payments for Q1 and Q4 if you didn't sell any homes.

You can make an estimated tax payment ANY DAY of the year!

Selling your home and expecting to owe capital gains? Receiving a dividend or stock payout? Make an estimated payment after the transaction is closed, regardless of the time of year. Pay the taxes before they ever hit your bank.

I'm a new business, how do I plan for this?

We recommend you open a separate bank account to start, and sweep tax due or projected tax due monthly into this separate account.

Review your numbers monthly and set aside a percentage of your take-home net profits. No idea how much? 30% is a safe start and then you can adjust as you get to know your tax rates and numbers better as time progresses.

With the money swept into this separate business account, DISTRIBUTE or take an owner DRAW to transfer these funds to your personal bank account and use these funds to pay your estimated tax payments from your personal bank.

Note that if you have more than one owner in your business, distributions must follow ownership percentages.

Estimated taxes are almost always an individual tax payment and should be paid by the taxpayer and not by the business!

Some businesses may have quarterly tax payments to the State to pay for their annual franchise taxes. Corporations pay tax, so they may also pay direct.

As a business owner, create this tax sweeping and saving habit and take care of your taxes due, avoiding the temptation of living off 100% of the income as it comes into your business.

As a business owner, we want that hard-earned cash and want all of it. The IRS and some states disagree.

Again, the last creditor you want knocking on your door is the IRS. And if you are living off 100% of your income, it is like you are taking a loan out from them every month....or every quarter in this case.

Summary

Paying estimated quarterly taxes ensures you stay compliant with IRS regulations and avoid unnecessary penalties and interest.

If you are new to paying estimated taxes, work with a tax advisor to help you estimate your payments.

Be proactive and make payments quarterly or as large transactions occur.

Remember, staying proactive with your taxes not only helps you avoid penalties but is also key to personal and business cash flow management throughout the year.