One of the side effects of filing our taxes each year is that many of us are introduced to estimated taxes. Depending on your situation, you may have to pay estimated taxes, but some people choose to do so as well. If you owed money with your 2007 income tax return paying estimated taxes is one way to prevent that from happening again. The other way would be to increase your withholding by submitting an updated W-4 with your employer. Estimated taxes payments can also be used to cover income not subject to withholding, such as self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards.
This post covers estimated tax payments to the federal government, but many states have estimated tax systems as well. Boiling estimated taxes down to their simplest form, they basically allow you to pay taxes throughout the year instead of owing a lot of tax (and potential penalties) at the end of the year. So if you were going to owe $4000 when you file your 2008 return you might pay $1000 at the 4 regular scheduled estimated tax due dates. For 2008, estimated tax payments are due (postmarked by) April 15, June 16, September 15, and January 15, 2009. The January 2009 payment can be skipped if your 2008 tax return is filed by February 2, 2009, and you pay the entire balance due with your return.
The general rule for who must pay estimated taxes in 2008 is those to whom both of the following apply:
- You expect to owe at least $1,000 in tax for 2008, after subtracting your withholding and credits.
- You expect your withholding and credits to be less than the smaller of:
- 90% of the tax to be shown on your 2008 tax return, or
- 100% of the tax shown on your 2007 tax return. Your 2007 tax return must cover all 12 months.
To determine how much to pay, use the estimated tax worksheet, which is on page 4 of IRS Form 1040-ES. Instructions provided with the worksheet will guide you through the form. Download Form 1040-ES from the IRS website.
As I said above, some people choose to pay estimated taxes even if they are not required to do so. The downside of doing this is that you are giving up your money sooner than you need to. Your money could be earning interest, or invested elsewhere, rather than being in the hands of the government earlier than it needs to be. That being said, many people prefer to have a few smaller tax payments throughout the year than owing a larger amount at the end of the year. Let’s say you sell some stock in July for a profit of $2000. Since you didn’t know about the sale at the beginning of the year, you wouldn’t have made payments on it in April and June. You could then figure out the amount of tax that would be due by the end of the year and split it between estimated payments in September and January. Or, if you had been making estimated payments, you could increase the amount for the last two payments to cover the taxes due on the stock profit.
If you are required to pay estimated taxes, make sure that you pay the necessary amount by the due dates. Underpaying, or paying late, can lead to penalties, even if you end up being owed money at the end of the year. To make a payment, you fill out a voucher, included in form 1040-ES and mail it to the IRS with a check or money order. After making one estimated payment, the IRS usually sends you additional vouchers and envelopes for the remaining payments. If not, additional vouchers are also included with form 1040-ES.
Like most tax topics, estimated taxes seem a little complicated at first, but there’s really not much to them. After you do a little work up front, the rest of the process is relatively simple.
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