Don’t Let Estimated Taxes Ruin Your Weekend Plans

As we mentioned last week, second quarter estimated taxes are due to the IRS on Monday, June 15.  You are likely required to pay these taxes if your employer does not withhold taxes for you (e.g., international organizations) or if you are part of the roughly 10 million self-employed work force in the US.

With only 3 days left, figuring out whether and how much you owe in estimated taxes is probably more than daunting.   Lucky for you, I completed my 1040-ES yesterday and read the IRS Publication 505, on withheld and estimated taxes, so that you don’t have to.  Here are the important points:

  • Deadlines. The due dates for the estimated tax payments (coverage period) are: April 15 (January 1-March 31), June 15 (April 1-May 31), September 15 (June 1-August 31), and January 15 of the following year (September 1-December 31).
  • Penalties. Pay your estimated taxes on time!  The penalty rates for underpayment 2008 were an annual rate of 5-6% for the number of days overdue.
  • Who has to pay estimated taxes. Generally, you must pay estimated taxes if (1) you expect to owe at least $1000 in taxes after withholdings and credits AND (2) you expect your withholding and credits to be less than (a) 90% of your 2009 taxes or (b) 100% of your 2008 taxes covering 12 months.
  • Who does NOT have to pay estimated taxes. If you were a US citizen or resident for all of 2008 and your tax year covered 12 months, but you did not have any tax liability for last year (i.e., your total tax came out to zero or you did not have to file a return), you do not have to file estimated taxes this year.
  • How much do you have to pay in estimated taxes? There are three ways to calculate your estimated taxes, listed from easiest to hardest:

1. Pay 100% of your 2008 taxes (or 25% each quarter).  Note: this year small business owners may be eligible to pay only 90%.

2. Pay 90% of the taxes you expect to owe in 2009 (or ¼ of that value each quarter).  Use the “2009 Estimated Tax Worksheet” that comes with form 1040-ES so that you can include deductions and credits in your calculations.

3. Use the Annualized Income Method to pay taxes on your earnings as you’ve earn them each quarter.  This method is most useful for people whose income is uneven throughout the year (i.e., you do not want to make an estimated tax payment if you have not earned any income over the respective quarter).

  • Consider your options. To avoid a penalty, you only have to pay the lowest value from methods 1 or 2, or the calculated value from method 3.  If you did not have an income from January to March (net of credits and deductions) or you missed the first quarter estimated taxes deadline, using the annualized income method may ensure that you don’t get penalized.
  • Check your 2008 tax return. If you overpaid taxes, did you ask to have some of it applied to your 2009 estimated tax (1040 line 74 or 1040A line 46)?  If so, you can count that against your minimum required estimated tax payments.
  • Payment. As with annual taxes, there are several different payment methods for estimated taxes.  If you, like most people, are paying by check or money order, make sure to send that with Form 1040-ES for Quarter 2 along with a slip that can be found on the IRS website, by Monday, June 15th.

And don’t forget to do the same for your state taxes!  The determinants for who has/does not have to pay as well as for the minimum payment are usually the same as for the federal taxes, though the penalty for underpayment might be even higher.  In DC, for example, the penalty is a 10% annual interest, compounded daily!

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