When starting a new job, you’ll need to complete a W-4 form, aiding your employer in determining the appropriate tax withholdings from your paycheck, which they then remit to the IRS. For most traditional employees, these withholdings typically cover their tax obligations, especially factoring in eligible credits or deductions. Consequently, they don’t typically need to concern themselves with making quarterly tax payments.
However, there are exceptions. Even with regular tax withholdings, individuals may still need to make quarterly payments if they earn additional income, such as from the gig economy or investments. Moreover, those who are self-employed or engage in freelance work are responsible for their own tax payments, akin to acting as both employer and employee. This includes fulfilling income tax and self-employment tax obligations, recognizing the dual role they play in managing their tax responsibilities.
Why Do You Need to Make Quarterly Payments?
You might be considering the option of paying your taxes in one lump sum when you file your return. However, the IRS requires taxpayers to make regular tax payments throughout the year. While it might seem advantageous to stash your tax payments in a high-yield savings account until tax season, the IRS discourages this practice. Failing to make quarterly payments can result in interest charges and penalties. It’s crucial to fulfill your tax obligations promptly and not wait until tax season rolls around.
How Much Should You Pay Each Quarter?
Quarterly estimated tax payments are essentially educated guesses. The IRS expects taxpayers to pay at least 90% of their total tax liability throughout the year. However, paying too much can also lead to penalties.
To calculate your quarterly payments, you can use Form 1040-ES. This form includes a worksheet to help estimate your current tax liability based on your earnings for the quarter and projections for the entire year. It also assists in calculating self-employment tax if applicable.
Alternatively, you can use the safe harbor rule, which involves dividing your previous year’s tax liability by four. As long as you pay 100% of the previous year’s taxes, the IRS will waive any penalties at tax time. This method is often preferred, especially if your income remains relatively stable from year to year.
Quarterly Tax Payments Throughout the Year
The IRS requires taxpayers to make quarterly tax payments to cover income earned in the previous three months. Here are the usual due dates:
- First quarter: April 15
- Second quarter: June 15
- Third quarter: September 15
- Fourth quarter: January 15 of the following year
If these dates fall on a weekend or a Federal holiday, the payment is due on the next business day.
Some self-employed individuals have a helpful approach to handling these quarterly payments. They make estimated monthly tax “payments” into high-yield savings accounts, earning interest before transferring the funds to the IRS every three months. This strategy helps them avoid the stress of large lump-sum payments every quarter.
They calculate the amount owed based on the previous year’s total tax liability and divide it by 12. Then, they transfer this monthly amount into a savings account. When it’s time to make the quarterly tax payment, they use EFTPS.gov to transfer the funds electronically from their savings account.
In contrast, some taxpayers, like myself, prefer to make quarterly payments as they’re due, using a credit card for payment. While payment processors charge a processing fee of about 2%, I benefit from my credit card rewards program, earning approximately 2.5% cash back with each payment. This means I earn around $5 for every $1,000 in tax payments, along with one month of interest-free credit.
Don’t Forget State Taxes
Don’t overlook your state taxes. You can adopt a similar strategy by paying 100% of what you owed to the state in the previous year. However, some states don’t require quarterly payments. If you’re in one of these states, you can choose to hold onto the money until tax time or deposit your tax liability monthly as part of your “tax payment” to yourself. By allowing the interest to accumulate throughout the year, you can maximize your earnings before sending the remaining amount to your state government.
But be cautious. If your income increases compared to the previous year, you might still owe money in April. Additionally, your new quarterly tax payment is typically due on the same day. Be prepared for the possibility of needing to make two federal tax payments around April 15. This could strain your finances if you’re not ready for it.
It’s crucial to stay informed about IRS updates. While the government extended the 2021 tax deadline and filing date due to the pandemic, the due date for estimated tax payments remained unchanged. So in some years, the due dates for taxes and estimated taxes may not align.
In Conclusion
For most individuals with income solely from regular employment, the concept of quarterly tax payments may seem unnecessary. If you fall into this category, count yourself fortunate. However, if you have additional tax obligations beyond your paycheck withholding, it’s crucial to familiarize yourself with the topic. Strategizing your tax payments plays a vital role in maintaining financial control.
Consistently allocating funds for “tax payments” into a designated savings account ensures you won’t find yourself scrambling at the last minute. This proactive approach helps you avoid accruing interest or facing penalties. Moreover, you may even earn some extra money through interest accumulation or by utilizing credit card arbitrage techniques (as I personally do). Of course, this strategy requires diligent credit card management to prevent falling into debt. But that’s a topic for another discussion — one we’ve got covered for you to explore further.