If you bring in income that doesn’t automatically have taxes withheld, you are expected to pay estimated taxes to the IRS each quarter. If you don’t, you will face penalty fines.
What Are Estimated Taxes?
If you have a side gig, freelance, or work as an independent contractor, you might owe estimated taxes. You will pay these taxes to the IRS quarterly for estimated taxable income that will not have taxes withheld automatically. Some situations that might produce taxable income subject to estimated taxes include:
- 1099 contractor positions
- Interest or dividends
- Alimony payments
- Capital gains
- Prizes or awards
Individuals owing more than $1,000 or more in annual taxes or businesses owing $500 or more should pay expected taxes. An individual includes sole proprietors, partners, and S corporation shareholders. The estimated taxes you pay will be used to cover income tax, self-employment taxes, and alternative minimum tax.
How Is Estimated Tax Calculated?
Individuals subject to estimated taxes can figure their quarterly payment by using IRS Form 1040. The estimated tax is calculated using:
- Expected adjusted gross income
- Taxable income
Because the taxes are estimated, you can use your return from the prior year to gather information and make a calculation. For complicated returns, it is usually best to work with a tax professional or financial advisor to ensure accuracy and avoid potential penalties.
What Is the Penalty for not Paying Estimated Taxes?
There is a penalty if estimated taxes are not paid. You also might face penalties if you make a payment, but underestimate the amount due. The IRS will calculate the amount you owe using:
- Amount of the underpayment, or non-payment.
- When the payment was due.
- Interest rates set by the IRS quarterly.
If you owe a penalty, you will receive a notice from the IRS. If you have questions about calculating your estimated taxes, you should consult with a financial advisor.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.