Who must pay estimated tax?

Estimated taxes must be paid by sole proprietors, partners in partnerships, members of limited liability companies, and shareholders of S-corporations who expect to owe at least $1,000 in federal tax for the year.

However, a taxpayer who paid no taxes last year—for example, because his or her business made no profit —doesn’t have to pay any estimated tax this year no matter how much he or she earns.

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How much in taxes do I have to pay?

Most people want to pay as little estimated tax as possible during the year so they can earn interest on their money instead of handing it over to the IRS. Yet, the IRS imposes penalties on those who don’t pay enough estimated tax.

To avoid penalties, a taxpayer must pay at least the smaller of:

• 90 percent of their total tax due for the current year

• 100 percent of the tax they paid the previous year or 110% if they’re a high-income taxpayer

High-income taxpayers—those with adjusted gross income of more than $150,000 ($75,000 for married couples filing separate returns)—must pay 110 percent of their prior year’s income tax.

The easiest way to calculate estimated taxes is to simply pay 100 percent of the total federal taxes paid last year, or 110 percent if a high-income taxpayer. This method can be used even by agents who weren’t in business that year, but the return for the year must have been for a full 12-month period.

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Other ways to calculate estimated taxes

There are two other ways to calculate the estimated tax that are more complicated, but might result in lower payments:

If you think your net income will be less this year than last year, you’ll pay less estimated tax if you base your tax on your taxable income for the current year instead of basing it on last year’s tax. The problem with using this method is that you must estimate your total income and deductions for the year to figure out how much to pay. Obviously, this can be difficult to compute accurately.

A much more complicated way to calculate your estimated taxes is to use the annualized income installment method. It requires that you separately calculate your tax liability at four points during the year—March 31, May 31, August 31 and December 31—prorating your deductions and personal exemptions.

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No matter what method you use to calculate your quarterly estimated taxes, it is always best to keep us in the loop on large changes to your projected profit/loss.  We will re-calibrate your estimated payments, along with starting to strategize how to minimize your tax bill before the end of the year on the projected changes.

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