Why Do We Have to Pay Estimated Taxes?
Our federal and state taxation is based on a pay as you go system. Your employer withholds taxes from you paycheck and sends those dollars directly to the IRS and your state government.
If you are self employed, or if you have other forms of income that are not pre-taxed, you are responsible for paying your taxes ahead by making quarterly estimated payments to the government.
Generally, there are three scenarios in which you do not need to make any estimated tax payments.
1. You expect to owe less than $1,000 in taxes for the tax year after subtracting your federal income tax withholding from the total amount of tax you expect to owe this year.
2. You expect your federal withholding taxes (plus any estimated taxes paid on time) to amount to at least 90% of the tax that you will owe for this tax year.
3. You expect that your federal withholding taxes will be at least 100% of the tax on your previous year's return or 110% if your adjusted gross income (AGI) on your tax return was over $150,000 ($75,000 if you're married and file separately).
If you meet any of these three requirements, you do not need to make estimated tax payments.
When the time comes to file your taxes, if you have not paid enough income taxes through withholding or estimated payments, you may have to pay a penalty for underpayment. Here are a few steps to follow to help you avoid this.
1. The safest option is to pay 100% - 110% of your previous year's taxes depending on your AGI (see #3 above). If you meet these amounts through withholding, you should not have to pay an underpayment penalty. Note: CA requires using the 90% rule if your current year income is over $1,000,000.
2. If you expect your income this year to be less than last year, pay at least 90% of your estimated current year tax bill or you may face an underpayment penalty.
3. If you expect your income this year to be more than your income last year, try to make enough estimated tax payments on your current year's income using the 100/110% of tax liability rule.
It is always important to stay on top of your taxes and not attempt to cut corners. If done correctly, these three techniques can help you to avoid underpayment penalties.
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