The tax law is pretty firm on the matter: You must pay taxes as you earn or receive income during the year. You can pay these taxes either through withholding or through quarterly estimated tax payments. You may have to make estimated tax payments if you receive income in the form of interest, dividends, alimony, self-employment income, capital gains, prizes or awards, or if the amount of income tax withheld from your salary or pension is too little. If you are in business for yourself, you generally will be required to make estimated tax payments.
You may owe an underpayment penalty if you fail to pay enough tax through withholding and/or through estimated tax payments. That’s the case even if you are due a refund when you file your tax return. The penalty for underpayment equals the product of the interest rate (using simple interest) times the amount of the underpayment for the period of the underpayment. The amount of the underpayment is the excess of the “required installment” over any amount paid on or before the due date of the installment. It is adjusted to reflect the number of days the underpayment is outstanding.
The period of underpayment runs from that due date to the earlier of: (1) April 15 following the end of the tax year or (2) the date the underpayment is paid.
Will You Have to Pay Estimated Taxes?
You can avoid having to pay quarterly estimated taxes if you receive a salary or wages by having your employer withhold a sufficient amount of income tax from your earnings. The Tax Withholding Estimator, found at www.IRS.gov, can help you determine whether the right amount of tax is being withheld from your paycheck. To have your employer withhold more tax from your earnings, you would have to file a new Form W-4 with your employer.
You will not have to pay estimated tax for the current year if you meet all three of the following circumstances:
- You had no tax liability for the prior year
- You were a U.S. citizen or resident for the whole period
- Your prior tax year covered a 12-month period