Who needs to make quarterly estimated tax payments?
For many people, taxes come due just once a year. But for others, it is necessary to make payments every quarter alongside the requisite filing due April 15.
Known as quarterly estimated tax payments, these are “taxes paid to the IRS throughout the year on earnings that are not subject to federal tax withholding,” said NerdWallet. Failing to make quarterly estimated tax payments when you owe them can result in a penalty, which is why it is important to know whether this applies to you. Here are the common situations in which quarterly taxes are owed.
People who do not have enough withheld
The general rule of thumb for owing quarterly estimated taxes is if “you’ll owe $1,000 or more in federal income taxes this year, even after accounting for your withholding and refundable credits,” said NerdWallet. You will also need to pay them if “your withholding and refundable credits will cover less than 90% of your tax liability for this year, or 100% of your liability last year, whichever is smaller.” That threshold increases to 110% for those with incomes over a certain amount.
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This situation could apply even to those whose employers withhold a portion of their income if not enough is held back to fully cover the tax owed. The amount of money that is withheld largely depends on the information employees provide on their W-4 form.
Those who are self-employed or earn business income
Taxes “typically aren’t withheld from self-employment income, so if you do any freelance, consulting or gig work, you should either pay quarterly income taxes or increase your withholding on other types of income to cover the shortfall,” said U.S. News & World Report.
If you own a small business, you should also anticipate needing to make these payments. “Individuals, including sole proprietors, partners and shareholders of S corporations, must make estimated tax payments on business ownership earnings if the total tax on built-in gains, excess net passive income tax and investment credit recapture tax is $1,000 or more,” said Investopedia.
Investors who realize large capital gains or receive other investment income
Capital gains, which occur when you sell an investment for a profit, can result in owing quarterly tax payments. “Any realized capital gains that can’t be offset by exclusions or capital losses are generally taxable and can be a trigger for making quarterly tax payments,” said Natalie Taylor, a certified financial planner and behavioral financial advisor in Santa Barbara, California, per U.S. News & World Report.
Other types of investment income can similarly trigger estimated taxes. This may include dividend and interest income, and rental income for landlords with rental properties.
Individuals who have made taxable retirement withdrawals
If you’ve been “saving in a tax-deferred retirement account, like a traditional IRA, and you make taxable withdrawals,” you can also end up owing quarterly taxes, said U.S. News & World Report. The same applies “if you earn enough income while on Social Security.”
You can, however, avoid making quarterly estimated tax payments in this case if you request that enough to cover taxes gets withheld from either your retirement account withdrawal or Social Security benefits.
