When you are employed, tax comes out of each paycheck before you see it. When you work for yourself, nobody does that for you, but the tax system still expects to be paid as you earn rather than in one lump at the end of the year. Estimated tax is the mechanism: payments you send during the year to cover income tax and self-employment tax on business profit. For many people in their first year of self-employment, it is the most unpleasant surprise. This section is here to make it an expected, routine part of running the business.
Who needs to think about it
In general terms, people expecting to owe a meaningful amount of federal tax that is not covered by withholding need to make estimated payments. The exact thresholds, safe-harbor rules and exceptions are set each year in the IRS instructions for individuals' estimated tax, and the guides in this section state them for the specific tax year they cover, with links to the official form.
Self-employed people with no other income almost always need to pay. People with a job and a side business may be able to cover the extra tax by adjusting withholding instead.
The rhythm of the year
Federal estimated tax is paid in installments with due dates spread across the year, and they are not evenly spaced by calendar quarter. The final installment falls in the following January. Many states with an income tax have their own estimated payments too, often on similar dates. Putting every date in a calendar at the start of the year is the simplest protection against missing one.
Figuring how much
There are two common approaches. One bases payments on the previous year's tax, which is simple and gives certainty. The other bases payments on a projection of the current year, which can be closer to what you will owe but requires a reasonable estimate. The IRS provides a worksheet for the calculation, and the guides walk through both methods with examples.
If income changes sharply during the year, you can recalculate and adjust later payments. There is also a method that matches payments to when income was actually earned, for people whose income is concentrated in part of the year.
The set-aside habit
The best estimated tax system is a savings habit. Each time a payment arrives, move a fixed share into a separate account reserved for tax. When a due date comes, the money is already there. The right share depends on your income, deductions and state, and refining it after your first tax return gives a better figure.
This habit also protects you from the most common self-employment cash crisis: spending money that was never really yours.
Paying
The IRS offers several ways to pay, including online options directly from a bank account. Paying online gives an immediate confirmation and removes the uncertainty of the post. Keep every confirmation with your tax records, because you will report the total on your return.
When payments fall short
Paying too little or too late can lead to a penalty, calculated on the amount and how long it was underpaid. The rules include safe harbors that protect you if you pay enough based on prior or current year tax, and waivers in some circumstances. The guides explain them for the tax year each one covers.
The guides in this section
The guides cover Form 1040-ES and its worksheet, how to calculate payments, paying when income is uneven, state estimated taxes, and what to do if you missed a payment. Each guide with figures states the tax year it applies to and links to the IRS source.
Guides in this section
- Form 1040-ES: who pays estimated tax, and how
Who must pay estimated tax, the payment schedule, the safe-harbor idea and how to pay the IRS.
- Estimated tax safe harbor: paying enough to avoid a penalty
How the prior-year and current-year tests work, who uses the higher prior-year test, and how to schedule payments around them.
- The estimated tax underpayment penalty
How the IRS calculates the penalty, how to avoid it, and when it can be reduced or removed.