Photo credit: Ken Teegardin / Flickr
Self-employed persons, rental property owners, and investors may need to pay estimated taxes throughout the year. As a reminder, June 15th is the deadline for paying the second installment of estimated taxes for the year 2018.
Here are six tips to help save you some time and money.
1. When are the estimated tax payments dates for tax year 2018?
Federal estimated tax payments are due quarterly on the following dates:
April 17, 2018(already passed)
- June 15, 2018,
- September 15, 2018, &
- January 15, 2019.
2. When should someone start making estimated tax payments?
The US tax model is a “pay-as-you go” tax system. The IRS wants your money throughout the year, instead of all-at-once on April 15th of next year.
This is usually not an issue for most Americans who earn most of their income from wages, as their employers are required to withhold a portion of each paycheck for taxes.
Basically, any time you receive income that is not withheld upon you should consider making an estimated tax payment. Some of the most common examples include: interest, dividends, capital gains from sale of stock or business, the sale of home, rental income, and self-employment or freelance income.
As a general rule, if you expect to owe over $1,000 in taxes for the year 2018 you are required to make federal estimated tax payments.
3. Why make estimated tax payments?
Why should someone pay estimated taxes now, when they could pay in full next April 15th?
The first reason is to protect yourself from estimated tax penalties. You can be subject to a 3% penalty on any unpaid taxes when you go to file your taxes in April.
The second reason is for cash flow management. The estimated tax payment is likely the result of an event from which you received cash (for example, when you sold your home). Before spending the cash, it’s best to make the appropriate tax payment to the government so you are not stuck in a stressful situation when April comes around.
4. How much do I have to pay?
This is a two part answer.
First, the payment is calculated by looking at the total tax reported on line 63 of your 2017 tax return. This amount is multiplied by 110% and then divided by four so that 25% is paid in each quarter.
The second step is to calculate your estimated tax liability for 2018 (this can be a difficult task). After calculating your estimated tax liability for the year, we divide that up into four installments of 25% each quarter.
Let’s look at a quick example.
Olivia works as a graphic designer at Google. She also freelances on the side. In 2017 Olivia’s total tax liability was $25,000. In 2018, Olivia is bringing in even more freelance income, and so we estimate her 2018 total tax liability will be closer to $28,000. Olivia will have about $20,000 of federal tax withheld from her paycheck. That leaves about $8,000 of federal tax that Olivia will need to pay in herself through estimated taxes.
How much does she have to pay in June 15th, 2018?
First, we multiply $25,000 (last year’s total tax) by 1.1 to arrive at $27,500.
Next, we estimate Olivia’s total tax for 2018, which we think might be about $28,000. We then multiply this amount by 90%, which is $24,750.
Now we compare these two amounts and find out which amount is smaller. The smaller number is $24,750. We then subtract out the expected amount of tax withholding (approximately $20,000), leaving us a remainder of $4,750. At minimum, Olivia should be paying in at least $4,750 in estimated tax throughout the year — or $1,188 per quarter. This is the bare minimum to avoid the estimated tax penalty. If Olivia decides on paying the bare minimum, she will end up owing a balance due of approximately $3,250 next April (the difference between her actual total tax liability for the year 2018 minus the $24,750 she pays in through a combination of withholding and estimated tax payments).
However, we might recommend that Olivia pay in $8,000 in estimated that throughout the year — or $2,000 per quarter. Paying in this amount will ensure that Olivia pays in the full amount of expected tax, thereby avoiding any large tax payments in April.
5. Be proactive with state estimated tax payments.
States also require that estimated tax payments be made as well. While every state is different, most states tend to follow the federal due dates and use the same approach to calculating taxes due. Be careful of California estimated tax payments as 70% of the tax is required to be paid in by June 15th.
6. Pay your estimates online.
Making payments is relatively straight forward. The IRS will allow you to make payment via bank draft on their website (www.irs.gov/payments). Most states now also allow for online payments.
Calculating your estimated taxes during the year is like trying to hit a moving target. Working with a Visor tax advisor can help mitigate unintended consequences and avoid a big tax bill come April.
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