Why do I have estimated tax payments?

A popular misconception is that federal income taxes are due by April 15. Actually, taxes are due when the income is earned. This may seem like an unimportant subtle fact to most of us, but it is an absolute guideline to the IRS.

The IRS does give us some leeway. April 15 is the deadline to file your return and pay any balance due. No penalty will be assessed if the balance due is less than $1,000 and it is paid by April 15. A failure to pay penalty will be applied to a balance over $1,000.

However, if an individual taxpayer has balance due after April 15, the IRS will levy a failure to pay penalty regardless of the amount due AND begin charging interest.

Most of us are familiar with income tax payments to the government in the form of withholding from wages, retirement plans and other income. There are types of income where taxes are generally not withheld, examples are interest, dividends, capital gains, partnerships and self-employment. To facilitate timely payment of taxes due the IRS has an estimated tax payment process.

Rather than requiring payments monthly or even weekly, estimated tax payments are due quarterly throughout the year on April 15, June 15, September 15 and January 15 (for the prior year).

You may use several methods to make an estimated tax payment.

You can send a paper check along with IRS Form 1040-ES. There are several options to pay electronically available on the IRS website (IRS.gov). You may enroll in the IRS Electronic Federal Tax Payment System (EFTPS), you can choose to use the Direct Pay option by giving the IRS the routing and account numbers of the account you would like to make the payment from, or you may pay by credit or debit card.

Finally, it is important to keep a record of the estimated tax payments you do make throughout the year as you will need to report these at tax filing time. Some of my clients make all of the estimated payments we set them up with, some make none, and others choose to make some payments of different amounts to set up.

A tax return cannot be accurately prepared without knowing the amounts and timing of any estimated tax payments.

Individuals, including sole proprietors, partners, and S corporation shareholders generally need to make estimated tax payments if they expect to owe federal income tax of $1,000 or more when their return is filed. You may be able to increase your federal withholding from other income sources to cover the tax liability from income sources without withholding to avoid paying estimated taxes throughout the year.

If you do not pay enough tax by the due date of each of the payment periods you may be charged a failure to pay proper estimated tax penalty, even if you are due a refund when you file your income tax return. It can be hard to understand that a penalty is assessed even though the total tax liability has been overpaid. The reason is due to timing, again the tax is due when the income is earned.

So, if the income is earned early in the year but the taxes are paid, or even overpaid, late in the year a failure to pay proper estimated tax penalty will be applied.

Some of my clients avoid making the estimated tax payments that we set up for them because they figure that they will just pay the balance due at the tax filing deadline.

However, if the taxpayer fails to make adequate estimated tax payments or have sufficient withholding then penalties and interest charges will result. I have a couple of clients who refuse to pay the estimated tax payments throughout the year, but are frustrated and upset when they incur penalties.

You really cannot have it both ways and need to choose whether you want to wait and pay the interest and penalties, or avoid those and make the timely payments throughout the year if you would like to not pay them.