Hey guys, today we’re talking about the estimated tax penalty because it’s a sneaky tax and most people don’t even realize what it is.
It can cost you thousands and thousands of dollars as your income increases. And of course, we want to make sure that you are doing everything you can to minimize your tax liabilities.
So in this post, we’re going to talk about everything you need to know about the estimated tax penalties.
Now some people see this every year on their tax return and think it’s just another required payment to the IRS. But an estimated tax penalty is something that you DO NOT have to pay and can be completely avoided.
So right now, we’re going to explain what you need to know about estimated tax penalties so you can start saving more on your annual tax returns.
Also, I’m going to show you how to calculate and pay your federal estimated taxes.
Ok now let’s define what is an estimated tax penalty?
What is an Estimated Tax Penalty?
So if you are self-employed, then generally you are required to pay your taxes 4 times a year.
Now hold on, your total tax liability won’t change, but rather you just have to split it up and make more payments.
Say for example, your tax liability last year was $10,000. So if you expect your liability will be the same then you would divide $10,000 by 4 and pay $2500, 4 times throughout the year.
Now the reason it’s called estimated tax payments is because you’ve estimated how much income you’ll make this year, and paying taxes on that amount.
Another popular question is, “Do you have to make estimated tax payments?”
So, if you file under business classifications like a sole proprietorship, a partnership, S-corp shareholder or just self-employed individual and you owe $1,000 taxes or more then you generally will need to make quarterly payments.
On the other hand, if you’re a W2 employee, you generally don’t need to make any estimated tax payments because your employer will handle tax payments for you.
But if you are doing any kind of business whether you are a freelancer, contractor or self-employed, you will likely need to make tax payments.
Now there are 3 super specific instances where you MAY NOT need to make estimated tax payments.
And so you must meet these 3 requirements:
- You did not owe any taxes in the previous tax year, and was not required to file a tax return.
- You were a US citizen or resident for the entire year.
- Your tax year was 12 months long.
So as long as you meet these 3 requirements then you can avoid the estimated tax penalty, but that is a very small percentage of people who will qualify.
Ok, so now that we know what estimated tax penalties are and who has to pay, the next question usually is when are they due?
When are Estimated Tax Penalties Due?
So as we already explained, tax payments are due 4 times per year and it’s usually due on the 15th of the next quarter.
So in the beginning of 2020, the schedule was set up like this.
- For the period of January 1st to March 31st, the quarterly tax payment due was April 15, 2020.
- Then, for the period of April 1st to May 31st, payment was due June 15th.
- Next, for the period of June 1st to August 31st, payment was due September 15th.
- And for the period September 1st to December 31st, payment is due January 15, 2021.
Now it’s a smart idea to put these due dates in your calendar so you can make the payments on time or even a little bit before.
And of course, with this sickness going on in the world, some due dates were extended and it is possible that they are extended again.
But as of now, they only extended 2 out of the 4 payments, here’s what the schedule looks like:
Ok so we understand what estimated tax payments are, we know who has to pay them and now we know when they need to be paid, next question is how much do you have to pay?
How Much Do You Need to Pay for the Estimated Tax Penalties?
Let’s get to that.
Of course, this is going to be different for everyone, but I want to spend some time breaking down the math as simply as possible.
Now to help us illustrate, we’re going to make up a fictional person who we’re going to call Jimmy.
Jimmy is a sole proprietor and would like to determine his estimated quarterly tax payments, based on his income and his self employed taxes.
Step 1: Estimate Your Taxable Income for the Year
Alright, so step number one for Jimmy is to estimate his taxable income for the year.
For instance, Jimmy estimates that his revenue will be $100,000 this year, but with that revenue comes some expenses. So let’s say he has $30,000 in deductible expenses.
So Jimmy’s gross income would be $70,000. But Jimmy qualifies for the standard deduction which is $12,200. With that said, Jimmy’s total taxable income is $57,800. So that’s how you get Jimmy’s taxable income for step number one.
By the way, if you want to learn more about small business tax deduction then make sure you read my post here.
Step 2: Calculate Your Income Taxes
Here, you want to start multiplying your tax income by tax year’s bracket, which here they are for 2020.
So as a single filer and income of $57,800, he’s going to go up to the 22% tax bracket and pay about $7,518.50 in taxes.
Now you can move on to step number three which is to calculate your self employment taxes.
Step 3: Calculate Your Self-Employment Taxes
Because Jimmy earned more than $400 this year, then he will have to pay a self employment tax. To do this, first you need to calculate your self employment taxable income.
So you need to take your total income, which in this example was $100,000. You then will multiply your total income, to get a small deduction, at 92.35% to get your self employment taxable income.
So Jimmy’s self employed taxable income is $92,350. Next you need to multiply this by self employment tax rate which is 15.3% which gives you $14,129.55
Then you’re ready to move on to the last step, step number four, add it all together and divide by 4.
Step 4: Add Them All Together then Divide by Four
So you want to take what we calculated in step number 2 which was the federal tax and add it to what we calculated in step number three which was the self employment tax.
So Jimmy will add $7,518 + $14,129 to get a total estimated tax of $21,647. He then will divide that by 4 and get an estimated quarterly payment of $5,411.75
And that is all the math.
You might want to ask, “Ok Sean, but what if I do this calculation wrong and I pay too much in taxes?”
Remember this, whatever you overpay in taxes, the government will send you a refund for that amount. Now of course, you want to be as precise as possible so that you can save your money, invest it or spend however you want.
Now paying the IRS has gotten super easy over the years and I’m going to show what you need to do. Please watch this quick walkthrough here.
In conclusion, the estimated tax penalty can be a pain, but completely avoidable but following the steps outlined in this post.
And if you need help with filing your business taxes then you’re in luck because that’s exactly what we do. You can visit our website, fill out the contact form, schedule a meeting and we would be happy to help.