When you work for someone else, your employer generally takes out an appropriate amount of taxes from your paycheck for your federal taxes. But when you're self-employed, a sole proprietor or the owner of an S-corporation, you're responsible for paying your federal taxes both as an individual and as a business owner. Estimated taxes are taxes set aside and paid during the course of the year in anticipation of owing the government a certain amount of tax at the end of the year.
Estimated taxes are usually a good idea, or even a requirement, in the following situations:
- You are a sole proprietor, partner, S-corporation shareholder or a self-employed individual who estimates you will pay $1,000 or more in federal taxes at the end of the year.
- You are filing as a corporation and you anticipate it will owe $500 or more in taxes for the year.
- You have a tax liability from the prior year, and have to pay an estimated tax this year.
How much your estimated taxes are depends on the total gross tax amount you anticipate owing. You'll need to estimate your expected adjusted gross income, taxable income, deductions, taxes and credits for the year. IRS Form 1040-ES can help you calculate your estimated taxes for the year, but it can get complicated.
Also, it has to be done frequently. Estimated taxes are usually paid quarterly, in the month following the close of the previous quarter. For example, Quarter 1 taxes are paid in April, because the quarter ends in March. Estimated taxes can be paid on the IRS website using the free online tools provided.
What happens if you don't pay estimated taxes? The IRS frowns on companies and individuals who fail to pay taxes, of course. The same goes for estimated taxes. They'd prefer that businesses pay into the tax pool along the way, and if necessary, get a refund for overpayment later.
Who doesn't have to pay estimated taxes?
If you're undecided about whether you should pay estimated taxes, speak with a qualified professional. The IRS provides general guidelines too. If you meet all three of the following criteria, without exception, then you may be able to waive estimated taxes:
- You were a U.S. citizen or resident for the whole year.
- You had no tax liability for the previous year.
- Your prior tax year covered a 12-month period.
But everyone else may be on the hook.