The human brain is a funny thing. Somehow, it’s easier for us to spend $40 on a product with “free shipping,” than $35 for the same product with a $5 shipping fee. It’s easier to commit to 4, 30-minute TV episodes than to a 2 hour movie. And even though walking through the parking lot would only take 30 seconds, spending 5 minutes looking for a spot close to the entrance seems like a time-saver.
The takeaway: we can’t trust our brains to make rational decisions, especially when our time or money is involved. This is why so many taxpayers choose to not make their estimated payments. Our brains tell us that sending MORE payments to the IRS means we’re spending MORE money on taxes. Guess what? Your brain is lying to you. The reality is, estimated tax payments SAVE you money.
How? Well first you need to understand you’re up against more than just income & self employment taxes.
The Infamous Underpayment Penalty
Before we get into this, you might want to pour yourself a drink. Don’t worry, I’ll wait.
To understand this penalty, think of the IRS as a credit card agency, only less fun. For every dollar you earn, the IRS gets a slice. And while you wait till April 15th to pay them their share, unbeknownst to you their share is actually accruing interest. By the time you file your taxes, you get slammed with a 5-6% interest rate, or “underpayment penalty,” on your outstanding taxes. Sweating yet? It gets worse. For those people who extend their returns (and don’t pay the full balance with their extension), their unpaid tax begins to accrue late-payment penalties & additional interest every month until the balance is paid.
Let’s look at an example:
Assume your self employment earnings are $24,000
Your tax bill is roughly $4,500 (self employment tax + regular income tax)
$4,500 x 7% = $315 underpayment penalty 😟.
Total bill: $4,815. Now let’s say you extend and don’t get around to preparing & paying your taxes until July 15th, so the bill is 3 months overdue. ($4,815 x .005) x 3 = $72.25 late payment penalties.
Your new tax bill: $4,887. $387 of that is just fees & penalties 😵😭. Aren’t you glad I made you pour that drink? Luckily, it gets better from here.
No penalty when you make estimated payments!
The IRS generously decided to wave their underpayment fee under the condition that taxpayers make payments throughout the year (usually known as “withholding”).
If your withholdings are equal to either:
a) 100% of prior year taxes, or
b) 90% of current year tax liabilities,
No underpayment penalty will be assessed.
There is a catch though: payments have to be made consistently through-out the year. You can’t make one big payment in December and think you’re covered. No, no, the IRS wants their money in real time (you greedy, selfish taxpayer, you 😑). Remember, your taxes begin accruing the moment you earn your first dollar. Consequently, the IRS requires that payments be made quarterly in order to avoid being frozen in carbonite--err the 6% underpayment penalty.
Estimated tax payments are due on or before the following dates:
- April 15th (1st quarter)
- June 15th (2nd quarter)
- September 15th (3rd quarter)
- January 15th (4th quarter)
If those dates fall on a weekend or federal holiday, you generally have until the next business day to send them in. Payments can be made online or through the mail. If you aren’t sure how much to pay, never fear! Keeper has your back. Check out our handy-dandy quarterly tax calculator to figure out how much you should pay.
Exceptions. Not all of you needed to read this article!
Some taxpayers won’t be subject to the underpayment penalty and are therefore exempt from making quarterly payments. Examples include:
W2 employees who withhold from their paychecks (assuming their withholdings are accurate)
Individuals who owe less than $1,000 after withholdings & credits have been subtracted -First-year offenders. The IRS will waive the penalty the first time someone is underwithheld.
Even though it’s never fun to pay taxes, you can save a lot on penalties by making estimated tax payments. Think of it as making payments on a credit card. Timely payments = no penalties or interest! Are there rewards points? No. Will it improve your credit score?? Also no. But it will save your bank account when it comes down to it. If your brain really needs the extra help, ask yourself, how many $7 bottles of wine could get by avoiding a $200 underpayment penalty? 28. You could get an additional 28 bottles of wine this year 100% guilt free. You’re welcome. Now go make your upcoming quarterly tax payments!