Understanding Quarterly Estimated Taxes

When you don't have taxes automatically withheld from your income, the IRS expects you to pay as you earn. This is where quarterly estimated taxes come in—a system designed to collect tax throughout the year rather than in one annual payment.

This guide explains how estimated tax payments explained works, who needs to make them, and what happens when they're required.

What Quarterly Estimated Taxes Are

Quarterly estimated taxes are advance payments on your annual tax liability. They cover both income tax and self-employment tax for people who don't have taxes withheld from their earnings.

The system mirrors the pay-as-you-go approach used for employees, who have taxes taken out of each paycheck. The difference is that you calculate and send these payments yourself rather than having an employer do it for you.

These payments aren't a separate tax—they're simply prepayments toward your total tax bill for the year. When you file your annual return, you'll account for these payments, and they'll reduce what you owe or increase your refund.

The IRS divides the year into four payment periods, each with its own due date. Missing these deadlines or underpaying can result in penalties, even if you pay the full amount when you file your return.

Who Needs to Make Estimated Payments

Not everyone is required to pay quarterly estimated taxes, but certain situations trigger this obligation.

Self-employed individuals typically need to make estimated payments because no taxes are withheld from client payments or business income. This includes freelancers, independent contractors, sole proprietors, and partners in partnerships.

People with significant income from sources that don't withhold taxes also need to pay quarterly. This includes:

• Rental property income

• Investment income like dividends and capital gains

• Retirement account distributions without withholding

• Prizes, awards, or gambling winnings

Even if you're employed but have substantial side income, you may need to make estimated payments on that additional income if your withholding doesn't cover it.

There's a minimum threshold for estimated payments. If you expect to owe below a certain amount after withholding and credits, you're not required to make quarterly payments.

You also don't need to make estimated payments if your withholding covers enough of your expected tax liability—generally, if you'll have withheld at least a high percentage of what you owe.

How the Payment Schedule Works

The tax year is divided into four payment periods, but they're not evenly spaced across calendar quarters.

The first period covers income earned in the first few months of the year. The second period covers the next couple of months. The third period covers the summer months. The fourth period covers the final months of the year.

Each period has a specific due date, typically falling on the 15th of the month following the period's end. If the 15th falls on a weekend or holiday, the deadline shifts to the next business day.

You can pay more than required in any quarter, which will apply toward your annual tax liability. You can also adjust payment amounts throughout the year if your income changes significantly.

Missing a payment deadline doesn't prevent you from making future payments, but you may face underpayment penalties for the period you missed.

Calculating How Much to Pay

The amount you need to pay each quarter depends on your expected annual income and tax liability.

There are two main approaches to calculating quarterly estimated taxes:

The current year method involves estimating your total income, deductions, and credits for the year, calculating your expected tax, and dividing by four. This works well if your income is predictable.

The prior year safe harbor method bases payments on your previous year's tax liability. If you pay a certain percentage of last year's tax (higher for high-income earners), you'll avoid penalties even if you end up owing more this year.

Your calculation should account for:

• Expected business or self-employment income

• Other income sources not subject to withholding

• Anticipated deductions and credits

• Self-employment tax on net earnings

If your income fluctuates significantly during the year, you can use the annualized income method, which adjusts each payment based on actual income earned during that specific period rather than assuming even quarterly income.

Making Payments and Keeping Records

Several methods are available for submitting quarterly estimated taxes.

You can pay electronically through the IRS website, which provides immediate confirmation and is generally the fastest and most secure method.

Check or money order can be mailed with a payment voucher, though this takes longer to process and doesn't provide instant confirmation.

Some taxpayers use tax software that calculates estimated payments and facilitates electronic submission.

For each payment, you should keep records showing:

• The amount paid

• The date of payment

• The tax period it applies to

• Confirmation or receipt numbers

These records are essential when filing your annual return, where you'll report the total estimated payments made during the year.

What Happens If You Don't Pay

Failing to make required estimated payments, or underpaying them, can result in penalties and interest.

The underpayment penalty is calculated based on how much you should have paid, how much you actually paid, and for how long the underpayment existed. It's essentially interest on the amount you should have paid but didn't.

This penalty applies even if you're owed a refund when you file your annual return. The issue isn't whether you ultimately owe money—it's whether you paid enough throughout the year.

However, penalties can be waived in certain situations:

• If the underpayment was due to a casualty, disaster, or unusual circumstance

• If you retired or became disabled during the tax year

• If the underpayment was reasonable and you made a good-faith effort to comply

The penalty calculation can be complex, and it varies based on federal interest rates, which change quarterly.

Adjusting Payments During the Year

Your income or expenses might change significantly after you've made estimated payments, and you can adjust future payments accordingly.

If you earn more than expected, you can increase later payments to avoid underpayment penalties. You don't need to go back and adjust previous payments—just pay more in remaining quarters.

If you earn less than expected, you can reduce future payments. This prevents overpaying and having too much money tied up with the IRS until you file your return.

Life changes that might warrant adjustments include:

• Gaining or losing a major client if you're self-employed

• Significant changes in investment income

• Large one-time expenses that create deductible losses

• Marriage, divorce, or having children (which affect credits and deductions)

Some people find it helpful to recalculate after each quarter based on actual year-to-date income and expenses, then adjust the next payment accordingly.

Employees With Side Income

If you have a regular job with withholding but also have side income, you have options beyond making estimated payments.

You can increase withholding from your regular job by submitting a new W-4 to your employer. If the increased withholding covers the tax on your side income, you won't need to make separate estimated payments.

This approach simplifies things because you're still using the regular withholding system rather than making separate quarterly payments.

However, if your side income is substantial or your employer can't withhold enough, estimated payments may still be necessary for the portion not covered by withholding.

Withholding is considered paid evenly throughout the year for penalty calculation purposes, even if it actually occurs later in the year. Estimated payments are credited only when actually made, which makes withholding advantageous in some cases.

When questions arise about whether you need to make estimated payments or how much to send, the team at Portentrade can provide the guidance you're looking for.