Estimated Taxes and the Estimated Tax Penalty

How much estimated tax should you be paying?

A woman sits at a home table calculating taxes with piles of paper and a laptop
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Paying estimated taxes helps to ensure that you're giving the Internal Revenue Service (IRS) enough money during the year to avoid owing a lump sum at filing time—or, even worse, incurring penalties. Taxpayers should consider making estimated tax payments if they earn certain types of income that aren't subject to tax withholding. These can include self-employment income, rental income, investment income, and capital gains.

You might want to consider making estimated tax payments even if you don't have any of these types of income. The payments can also cover taxes you might owe but didn't have withheld from unemployment compensation or from the income you might have earned in a side gig.

Key Takeaways

  • The IRS doesn't want to wait until the end of the year to collect what you owe in taxes, so it requires that certain taxpayers pay as they go by making estimated tax payments.
  • W-2 employees are exempt because they already have taxes withheld from their paychecks. But they can remit estimated payments if they want to, maybe because they suspect that their W-2 withholdings won't cover all their taxable income.
  • The general rule of thumb is that you should pay estimated taxes if it's likely that you'll owe the IRS $1,000 or more when you file your tax return.
  • For individual taxpayers in Q4 2022, the rate for overpayments and underpayments will be 6% per year, compounded daily, up from 5% in Q3 2022.

Who Should Pay Estimated Taxes?

No law or rule prohibits you from paying estimated taxes. You can do so if some unforeseen circumstance crops up during the tax year that makes you think that the taxes that are being withheld from your paychecks might not be enough. The IRS will send you any excess as a tax refund if you end up paying too much.

However, the IRS sets requirements for which taxpayers generally must make estimated payments. The rule is that you should do so if you expect to owe $1,000 or more when you file your tax return.

Estimated Tax Payment Deadlines

Estimated tax payments have quarterly due dates throughout the year. Penalties and interest can accrue if you pay after these dates:

  • April 15
  • June 15
  • September 15
  • January 15

The Estimated Tax Penalty

The penalty for unpaid estimated taxes typically applies if you don't make sufficient payments by the quarterly due dates and if it turns out when you file your tax return that you should have. You can usually avoid paying a penalty if it turns out that you owe less than $1,000 when you file if you've made estimated payments of at least 90% of what you owe for the current year or 100% of your total tax due on your previous year's return, whichever is less.

The penalty is essentially an interest charge. The IRS sets the rate each quarter at the federal short-term rate plus three percentage points. The interest rate for underpayments by individual taxpayers for the fourth quarter of 2022 is 6%. It increased a full percentage point from the third quarter of 2022 and 3% from Q4 2021.

Note

Interest compounds daily and is typically added to any unpaid tax from the time the payment was due until the date the tax is paid.

How to Calculate Your Tax Payments

Look at last year's tax return to find your total tax liability, then subtract any withholding you expect to pay or have paid for this year from other income sources. You can subtract last year's withholding amount if your withholding will be about the same. The balance is the amount of income on which you'll owe tax.

You can divide any expected shortfall on withholding by four to get your quarterly estimated tax payment. Divide by 12 if you'd prefer to remit your estimated payments monthly.

This method works if you haven't experienced any major changes since last year. You're earning about the same amount, and it's likely that you'll still have the same marital status and the same number of dependents throughout the current tax year.

Note

Divide by the number of quarters or months remaining in the tax year if you're beginning to make estimated payments later in the year.

IRS Publication 505 and Form 1040-ES provide worksheets to help you calculate what you'll likely owe in estimated taxes. Using these worksheets might be your safest option if you've experienced multiple or significant changes.

Calculating Your Income

Suppose you're an independent contractor, and your business is your only source of income. You have $25,000 in self-employment income and $7,500 in business expenses in the first quarter (three months) of 2022, resulting in a net profit of $17,500.

Your business isn't seasonal, so it's safe to say that your income and expenses will be similar throughout the remaining nine months of the year. Multiplying your net quarterly profit of $17,500 by four indicates that your net profit for the full year will be $70,000.

Your income will be subject to both income tax and the self-employment tax because you're an independent contractor. So your taxable income for the year would break down like this:

  • Self-employment tax: $9,890 ($70,000 x 0.9235 x 15.3%)
  • Deduction for half of the self-employment tax: $4,945
  • Standard deduction for a single person: $12,950
  • Taxable income: ($70,000 – $4,945 – $12,400) = $52,655

Note

The $12,950 standard deduction applies to the 2022 tax year, so you can plan going forward, making the necessary payments as the year progresses. It was $12,550 in 2021, if you're calculating retroactively. Standard deductions tend to change annually to keep pace with inflation.

Calculating Your Estimated Payments

Based on the tax brackets for 2022 for a single person, we can calculate your estimated income tax like this:

  • 10% on your income up to $10,275 = $1,027
  • 12% on your income from $10,276 through $41,775 = $3,780
  • 22% on your income from $41,776 through $52,655 = $2,396

These amounts add up to a total estimated income tax of $7,203 ($1,027 + $3,780 + $2,396).

Adding this estimated income tax to your self-employment tax of $9,890 gives us the amount you should make in estimated payments over the course of the year: $17,093. That works out to $4,273 in quarterly estimated taxes, or $1,424 if you want to pay monthly.

How to Pay Your Estimated Taxes

You can remit estimated payments by check or by credit card, or you can use one of the Treasury Department's online bill payment systems.

Paying by Check

Make your check payable to the "United States Treasury." Be sure to write your Social Security number and the year for which you're paying in the memo field of the check. For example, you might write, "2022 Form 1040-ES, 123-45-6789."

Make sure to use the payment vouchers that come with Form 1040-ES. Mail your check along with a Form 1040-ES voucher ​to the IRS. The IRS publishes a list of addresses on its website that vary by state of residence.

Paying by Credit Card

The Taxpayer First Act allows the IRS to accept direct debit and credit card payments. You can find this option on the IRS's Payments web page. Fees for this service vary. They start at $2.20 for debit card payments and at 1.87% for credit cards. You can choose the payment process that suits your needs best when you click to pay.

The Electronic Federal Tax Payment System

The U.S. Treasury Department also operates two online payment systems. One is the Electronic Federal Tax Payment System (EFTPS). You're required to register and create an account to use this option. But then you can simply indicate the dollar amount and the date you want the payment withdrawn from your bank account.

EFTPS users can print a report showing their estimated payments for the year, which is handy to have at tax time. The system can take a few days to process new enrollments, but you can schedule estimated payments from your checking account very quickly once you're set up.

IRS Direct Pay

The second online payment system offered by the Treasury Department is Direct Pay. It's designed to handle payments of personal income tax only. But this includes most self-employed individuals. This service doesn't require registration or enrollment, but you'll have to enter your personal information each time you want to make a payment.

Both EFTPS and Direct Pay enable you to schedule federal tax payments from a checking or savings account.

Another Option: Withholding More From Other Income

You can adjust your withholding from your paychecks to cover estimated taxes on additional income if you also have income that's subject to withholding. Fill out a new Form W-4 to tell your employer how much additional tax you want withheld from your regular pay. You can indicate an additional dollar amount that you want your employer to withhold from each paycheck. You don't have to provide a reason.

Frequently Asked Questions (FAQs)

What are state and local estimated tax payments?

Federal estimated tax payments aren't the only ones you need to worry about. You'll also have to make estimated payments for state income taxes in most states, and even for local taxes in some cases. Deadlines and requirements can vary by state, so be sure to check with your state tax agency and consult a tax professional if necessary.

Where do I mail estimated tax payments?

Be sure you send the payment to the correct address for your tax jurisdiction if you pay your estimated taxes by mail. Check the IRS's list of addresses along with the mailing address for your state tax authority.

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