Are you planning on joining the gig economy and becoming self-employed? Are you embarking on retirement after years with a traditional employer? We wish you the best, and, along with the IRS, we remind you to pay your quarterly income taxes.
Without an employer to submit payments regularly out of your paycheck, you are now responsible for paying your own taxes in increments to fulfill America's pay-as-you-go tax requirements. You must make quarterly estimated tax payments if you expect to owe taxes of at least $1,000 for the year.
Underpayment of estimated taxes is on the increase, according to analysis of IRS data. The Wall Street Journal found a 40% increase in the number of taxpayers incurring penalties related to estimated taxes between 2010 and 2015, while a USA Today study found an increase of approximately 33% between 2007 and 2016. Making matters worse, the former reports that the potential number of filers owing penalties may be greater than the overall number of taxpayers filing estimated taxes – meaning that many filers made mistakes and others simply did not file their estimated tax payments at all. Perhaps this reflects more people entering the gig economy without an awareness of the rules or retiring without understanding the changes in tax requirements.
Don't be among those that are surprised by the tax laws. Review IRS Publication 505, "Tax Withholding and Estimated Tax" to familiarize yourself with your obligations, and keep these five tips in mind.
1. Don't Forget to Include All Income Sources – As you estimate your tax burden, make sure that you include revenue from interest, capital gains, dividends, royalties, and any other sources. Note that estimated tax also is used to pay self-employment taxes (and the alternative minimum tax if it applies to you).
2. Know the Due Dates – Quarterly tax payments for the tax year are generally due on the 15th of April for income received during January-March, the 15th of June for income received during April-May, the 15th of September for income received during June-August, and the 15th of January for the income received during September-December of the previous year. When those days fall on a federal holiday or a weekend, the deadline is moved up to the next business day. Payments sent by mail must be postmarked by the appropriate due date to avoid penalties. The IRS and Treasury Department have extended the 2020 tax filing deadline from April 15 to July 15, due to the COVID-19 pandemic. In the interest of safety and to curb the spread of the coronavirus, all Taxpayer Assistance Centers have been closed temporarily and face-to-face IRS services have been suspended until further notice. See the IRS Coronavirus Tax Relief page for the latest updates.
3. Use Safe Harbor Payments – You can insulate yourself from underpayment penalties by making safe harbor payments of at least 100% of your previous year's tax if you made less than $150,000 (married filing jointly), and 110% of your previous year's tax if your income was $150,000 or greater. You may still owe taxes at the end of the year, but you won't owe penalties.
4. Consider Annualized Income Installments – When your income is seasonal or generally uneven, it is difficult to predict your estimated taxes by quarter accurately. The annualized income installment method uses a different calculation method using building periods (each period includes all previous periods). See Publication 505 for further explanation and a corresponding worksheet.
5. Review Deductions and Credits – The estimated tax worksheet in Publication 505 includes calculations for credits and deductions, just like the standard Form 1040. You may qualify for different deductions and credits than you did before. Make sure that you fully review all of your tax reducing options.
Should you receive a CP30 notice from the IRS telling you that you have underpaid your taxes, you have a series of options, most of which require you to fill out Form 2210, "Underpayment of Estimated Tax by Individuals, Estates, and Trusts." Of course, with due diligence and proper payments, you can avoid CP30 notices altogether. Why not try that path instead?
Failing to pay your taxes or a penalty you owe could negatively impact your credit score. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.