As a freelancer, independent contractor, or self-employed worker, Tax Day can be more than just an annual hassle. In fact, depending on your self-employment income, you may be responsible for making estimated tax payments four times a year:
Unfortunately, not everyone is aware of these quarterly taxes, and even if you are, it's easy to accidentally miss a deadline. But don't worry, because in this article, we'll cover everything you need to know about what happens if you miss a quarterly estimated tax payment. This includes information on potential penalties and ways to avoid them.
But before we dive into that, let's first clarify who is required to make these payments in the first place.
Quarterly estimated tax payments are mandatory for self-employed individuals who anticipate owing $1,000 or more in taxes. However, not all freelancers and independent contractors are required to make these payments. If you work freelance on a part-time basis or as a side hustle, you may not need to worry about it.
In the US, we operate on a pay-as-you-go tax system. This means that employers are responsible for withholding taxes from their employees' paychecks and submitting those funds to the IRS. If you're self-employed and your taxable income meets a certain threshold, your quarterly estimated tax payments essentially take the place of that withholding.
By making these payments four times a year, you're covering both your income taxes and your self-employment taxes, which W-2 employees don't typically have to worry about.
While it may not be the most enjoyable task, there is some good news: you can reduce your tax bill by taking business write-offs. This is true whether you're making quarterly or annual payments. To help ensure that you never miss a write-off, consider using an app like Balance Pro. By scanning your receipts, this app can help you deduct anything you buy for work, from office supplies to software for your computer.
In addition to self-employed individuals, there are other taxpayers who are required to make quarterly tax payments. This includes those who earn income that is not subject to withholding, such as business earnings, dividends, gains from the sale of assets (like stocks), interest, and taxable alimony.
However, it's important to note that estimated tax payments are primarily associated with freelancers and small business owners, which is the focus of this article.
To calculate your quarterly tax payments, you should first determine your total tax liability for the year, including both income tax and self-employment tax. Next, divide that total by four to determine the amount you should pay each quarter.
If you prefer a more structured approach to calculating your estimated tax payments, the IRS provides a worksheet that can guide you through the process. This worksheet can be found on page 8 of Form 1040-ES, also known as "Estimated Tax for Individuals."
You don't need to submit this worksheet to the IRS when you make your estimated tax payments. It's simply a tool to help you calculate the appropriate amount to pay each quarter.
It's crucial to make your quarterly tax payments by the deadline set by the IRS. If you miss a payment, it's important to make it as soon as possible. Some people might assume that they can simply make up the missed payment during the next quarter, but this is a mistake.
The reason is that the underpayment tax penalty is determined based on the amount you owed and how long it took for you to make the payment. In other words, the longer you wait, the more you'll end up paying in penalties.
If you find yourself unable to pay the full amount due for your quarterly estimated tax payment, it's still important to make a payment by the deadline. Even if you can only pay a portion of what you owe, making a partial payment can help reduce the penalty amounts you'll be responsible for.
The key is to pay as much as you can by the deadline, rather than waiting until you can pay the full amount. We'll dive deeper into the penalties and options for reducing them in the next section.
The tax underpayment penalty is a fee imposed by the IRS when you fail to pay the full amount of your estimated taxes by the deadline. The penalty is typically 0.5% of the total amount owed and increases for each month that the tax remains unpaid. The penalty is capped at 25% of the total amount owed.
In addition to the tax underpayment penalty, there is also an interest charge for missed payments. It's worth noting that the interest rate for missed payments can change from quarter to quarter, which means that the actual penalty you'll owe may fluctuate.
It's important to note that the IRS calculates penalties for missed quarterly tax payments on a quarterly basis. This means that you could end up owing a penalty for underpayment in a specific quarter, even if you've paid the correct amount for the year overall.
Furthermore, it's possible to overpay your estimated taxes for the entire year and still be penalized if you were short for a specific quarter. For example, if you missed the June 15 payment but made an extra payment in September to make up for it, you would still be subject to a penalty for the missed June payment.
In some cases, you may be able to avoid penalties for missed quarterly tax payments through the use of safe harbor rules. These rules provide protection from penalties under certain conditions, depending on your business's adjusted gross income (AGI).
If your AGI is $150,000 or less, you won't have to pay penalties if you met 100% of last year's tax liability in equal payments across all four quarters. If your AGI is more than $150,000, you won't have to pay penalties if you met 110% of last year's tax liability in equal payments across all four quarters.
It's important to note that these safe harbor rules are based on your tax liability from the previous year, which can be frustrating if you earn significantly more in the current year. While you won't be subject to penalties, you will still owe tax on the additional income when you file your annual return.
For example, if your gross income for the prior year was $50,000 and it jumped to $100,000 for the current year, you can make your quarterly tax payments based on the $75,000 and avoid penalties. However, you will still need to pay tax on the extra $25,000 as a lump sum on April 15.
Calculating the amount of penalty owed for missed quarterly tax payments can be a complex process that involves multiple factors, including the amount paid, the number of days late, and the interest owed. As a result, most people are not expected to calculate this amount on their own.
If you're unsure about how much penalty you owe, it's best to consult with a tax professional who can assist you in determining the appropriate amount. They can help you understand the calculations involved and ensure that you're paying the correct amount to the IRS.
In most cases, the IRS will calculate the amount of penalty owed for missed quarterly tax payments on behalf of taxpayers. When you file your tax return, you can simply leave box 38, which is for "Estimated tax penalty," blank on your Form 1040.
The IRS will then calculate the penalty amount owed and send you a bill for the total amount due. This can simplify the process of calculating your penalty and ensure that you're paying the correct amount owed to the IRS.
There are some cases where taxpayers may not have the option of waiting for the IRS to calculate their penalty and will need to calculate it themselves. This applies only under specific circumstances:
The third situation is relatively rare and may occur if your employer withheld taxes in a manner that is different from the standard method of splitting it into four equal chunks.
If you fall into any of these categories, you will need to calculate your penalty yourself using the worksheet on Part III of Form 2210, which is titled "Underpayment of Estimated Tax by Individuals, Estates, and Trusts."
While tax underpayment penalties can be frustrating to deal with, the IRS recognizes that they can be unfair in certain cases. As a result, they have established a few ways to potentially get out of these penalties.
The first option is available to self-employed individuals with highly variable income. This option involves using the annualized income installment method, which allows you to base your estimated tax payments on your actual income for each quarter rather than assuming equal payments for each quarter. This method can help reduce the underpayment penalty for taxpayers who experience significant fluctuations in their income throughout the year.
The second option is available to taxpayers who experience special circumstances that prevent them from paying on time. This may include natural disasters, medical emergencies, or other unforeseen events. In these cases, you can apply for a penalty waiver or abatement, which may allow you to avoid or reduce the penalty owed. It's important to note that the IRS is selective when granting penalty waivers, and you'll need to provide documentation to support your claim.
For individuals with highly variable income, such as gig workers, sole proprietors, and business owners, estimating quarterly tax payments can be challenging. Unlike those with regular W-2 jobs, there's no guarantee of consistent income throughout the year.
For example, a seasonal business might see high revenue during the summer months but little during the winter. Or, a side gig might be busier at certain times of the year than others. This uneven income can create stress when it comes to making estimated tax payments.
Fortunately, the IRS has established the annualized income installment method, which allows taxpayers to base their estimated tax payments on their actual income for each quarter, rather than assuming equal payments for each quarter. This method can be helpful for reducing the underpayment penalty for taxpayers who experience significant fluctuations in their income throughout the year.
The annualized income installment method is an alternative way of estimating and making quarterly tax payments for individuals whose income varies throughout the year.
Normally, quarterly tax payments are made using the regular installment method, which involves splitting your estimated tax liability into four equal payments. With the annualized income installment method, freelancers with variable income can pay lower taxes during times when they earn less without incurring penalties.
To use this method, taxpayers must calculate their annualized income installment using Schedule AI, which is found on page 3 of Form 2210. This form helps to determine the actual income earned during each quarter and adjust the estimated tax payments accordingly.
The annualized income installment method involves dividing the year into four periods using Schedule AI, which overlap to some extent. The first period runs from January 1 to March 31, the second from January 1 to May 31, the third from January 1 to August 31, and the fourth from January 1 to December 31, covering the entire year.
The pre-filled "annualization amounts" on line 2 of Schedule AI represent the proportion of the year that has elapsed at the end of each period. These amounts are used to determine the annualized income for each period by multiplying the adjusted gross income (AGI) for that period by the corresponding annualization amount. This calculation estimates the total annual income if the income for the whole year was the same as the income for the period.
For example, if the AGI for period (a) was $12,000, and the annualization amount for that period is 4, then the annualized income for that period is $48,000 ($12,000 x 4). The annualization amount for period (d) is 1, as this period represents the entire year.
Using this method allows freelancers with variable income to pay lower taxes during periods when they earn less, without incurring penalties.
Taxpayers who owe underpayment penalties may be able to apply for a waiver of the penalty. While many people don't know about this option, the IRS is generally lenient with penalties, especially if you can demonstrate that you are staying on top of estimated payments in the current year. If you can show that your underpayment was due to a "reasonable cause," such as a family death or a medical emergency, you will likely be granted a waiver.
However, if you are found to have engaged in "willful neglect," meaning that you intentionally ignored the payment, you will not be eligible for a waiver.
Are you worried about facing penalties from the IRS? There are some circumstances that could qualify you for a waiver. For instance, if you've become disabled, retired at age 62 or older, or experienced an unusual event like a natural disaster, the IRS may be willing to waive your underpayment penalties.
It's worth noting that if you've been affected by a federally recognized disaster, you may be eligible for an automatic waiver without needing to file any forms.
In addition, the First Time Penalty Abatement policy offers some leniency for those who are new to taxes or have gone three years without any penalties. If you fall into either of these categories, this policy could help you avoid penalties on your taxes.
Don't hesitate to reach out to the IRS if you think you might qualify for a penalty waiver. They may be willing to work with you to find a solution that works for your unique circumstances.
If you're looking to request a penalty waiver, you'll need to fill out Form 2210 and indicate the appropriate box in Part II. Box A is for full waivers, while Box B is for partial waivers.
Along with the form, you'll need to include a statement explaining why you weren't able to make your payments during the specified time period. It's also important to provide documentation to support your request. The type of proof you'll need depends on the reason you're asking for a waiver. For instance, if you're claiming a waiver due to disability, you'll want to include hospital records or statements from your disability insurance provider. Retirement waivers require proof of your retirement date and age, while casualty or disaster waivers may require police reports or insurance company documents.
Remember, missing a payment isn't the end of the world, and requesting a waiver can help alleviate the penalties. However, it's still important to make up the payment as soon as possible to avoid accruing additional penalties. Your future self will thank you for taking action sooner rather than later.
This post is for informational uses only and is not legal, business, or tax advice. Please consult with an attorney, business advisor, or accountant with concepts and ideas referenced in this post. Balance Pro assumes no liability for actions taken in reliance upon the information contained in this article.
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