Estimated Taxes: What they are and how to calculate them

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Page written by Ashlyn Brooks. Last reviewed on July 22, 2024. Next review due October 1, 2025.

It’s not a secret that no one enjoys tax season. From the complex codes to the changing stipulations and the looming deadlines, tax time is a persistent stress for many people. One factor in many people’s tax planning is understanding, calculating, and (of course) paying their estimated taxes each year.

This is particularly true for US small and medium-sized businesses (SMBs). Here at Swoop, we are well-versed in the financial aspects of running a business, including dreaded tax topics. While we don’t specifically assist with taxes as a specialty, we want to provide the basic information to get you off to the right start.

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What is estimated tax?

Estimated tax refers to the method of paying tax on income that isn’t subject to withholding. This includes income from self-employment, interest, dividends, rents, and alimony. Essentially, if you receive income in a form that doesn’t automatically withhold taxes, you’re likely responsible for paying estimated taxes.

Estimated taxes ensure that you pay taxes on income as it is earned rather than at the end of the year. This system helps prevent a large tax bill when you file your return, making it easier to manage your finances throughout the year.

How to calculate estimated taxes?

Calculating estimated taxes involves a few key steps:

Estimate your total income for the year: Include all sources of income, such as business profits, dividends, and rental income.
Subtract deductions and credits: Determine your expected deductions (like business expenses) and credits to reduce your taxable income.
Use IRS Form 1040-ES: This form includes worksheets to help you calculate your estimated tax.
Divide by four: Since estimated taxes are typically paid quarterly, divide your annual estimated tax by four to determine your quarterly payments.

Additional Tips:

Review previous tax returns: Use last year’s tax return as a reference to estimate your income and deductions for the current year.
Adjust for changes: Consider any changes in your financial situation, such as new sources of income or changes in deductible expenses.
Consult a tax professional: For personalized advice and to ensure accuracy, consult with a tax professional who can help you navigate the complexities of estimated taxes.

Who has to pay estimated tax?

You must pay estimated tax payments if:

You expect to owe at least $1,000 in tax for the year after subtracting your withholding and refundable credits.
Your withholding and refundable credits are less than the smaller of 90% of the tax shown on your current year’s tax return or 100% of the tax shown on the previous year’s return.

This applies to:

Self-employed individuals: Those who run their own businesses or work as independent contractors.
Business owners: Owners of small or medium-sized enterprises (SMBs).
Freelancers: Individuals who work on a contract basis and do not have taxes withheld from their payments.
Investors: Those with significant investment income, such as interest, dividends, and capital gains.

Example:

Sarah, a freelance graphic designer, receives payments from multiple clients throughout the year. Since none of these clients withhold taxes from her payments, Sarah must pay estimated taxes to cover her income and self-employment taxes.

Who does not have to pay estimated tax?

You may not need to pay estimated taxes if:

You receive a salary or wages where enough tax is withheld.
You had no tax liability last year and were a U.S. citizen or resident for the entire year.
Your tax liability will be less than $1,000 after subtracting withholding and credits.

John works full-time at a corporation, where taxes are withheld from his paycheck. He does not have any additional sources of income, and his tax liability is covered by the withholding, so he does not need to pay estimated taxes.

When is the estimated tax deadline?

Estimated tax payments are typically due on the following dates:

April 15: For income earned from January 1 to March 31
June 15: For income earned from April 1 to May 31
September 15: For income earned from June 1 to August 31
January 15 of the following year: For income earned from September 1 to December 31

Keep in mind some considerations

Adjust for weekends and holidays: If these dates fall on a weekend or holiday, the deadline is extended to the next business day.
Plan ahead: Mark these dates on your calendar and set reminders to ensure timely payments.

How to pay estimated taxes?

You can pay your estimated taxes in several ways

Online: Through the IRS Direct Pay service or the Electronic Federal Tax Payment System (EFTPS).
By phone: Call the IRS any time (24/7) at 1-800-829-1040

By mail: Send a check or money order and a payment voucher from Form 1040-ES.

Detailed Steps for Online Payment:

Visit the IRS Direct Pay website: Choose the “Make a Payment” option.
Select the reason for payment: Choose “Estimated Tax” and the appropriate tax year.
Enter your details: Provide your personal and payment information.
Confirm and submit: Review your details and submit the payment.

Tips for Managing Payments:

If you’re not making a lump sum payment, you may want to opt for automatic reminders. You can use calendar alerts or financial software to remind you of upcoming payment deadlines.

Also, consider setting up a separate bank account for your tax payments to avoid mixing them with your business funds.

What is the penalty for underpaying estimated tax?

If you underpay your estimated taxes, you may incur a penalty. The penalty is generally calculated based on the amount of the underpayment, the period (as in the time you waited) of underpayment, and the interest rate determined by the IRS.

Here’s how to avoid payment penalties

Pay at least 90% of the tax for the current year or 100% of the tax shown on the previous year’s return (110% if your adjusted gross income is over $150,000). Also, adhering to the quarterly deadlines can avoid late payments altogether.

What happens if I don’t pay estimated taxes?

We don’t advise procrastinating or failing to pay your taxes in any form. In fact, failing to pay estimated taxes can result in:

Interest charges: Accrued daily on unpaid tax from the due date of the return until the date of payment.
Penalties: For failure to pay estimated taxes and failure to file tax returns on time.
Collection actions: These include liens and levies on your property or assets by the IRS.

Consequences:

Increased financial burden: Interest and penalties can significantly increase your tax liability.
Damage to credit: IRS collection actions can negatively impact your credit score.
Legal issues: Continued non-payment can lead to more severe legal consequences.

How Swoop can help

At Swoop, we understand that running a business involves many responsibilities, including taxes. Although we can’t remind you of your tax deadlines, we can help you with funding.

With Swoop’s support, you can access the funding options you need to start or grow your business. Register with Swoop today and explore your potential funding options to ensure a smooth financial journey for your business.

Written by

Ashlyn Brooks

Ashlyn is a personal finance writer with experience in business and consumer taxes, retirement, and financial services to name a few. She has been published in USA Today, Kiplinger and Investopedia.

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