Quarterly Tax Payment Guide: When and Who Should You Pay?

The U.S. tax system is based on a "pay-as-you-go" concept. For the average employee with a W-2 this is automatically taken out as part of your paycheck. If you have income that isn’t subject to withholding — such as self-employed or freelance income, or small business earnings — it’s up to you to make Income and Self-employment Tax Payments throughout the year through Estimated Quarterly Tax Payments.

This comprehensive guide is oriented toward sole proprietors, freelancers, and small business owners who need to know their responsibilities so that they can stay on top of deadlines, calculations, and reporting to prevent penalties and headaches with the IRS. For the company leader overseeing remote teams or independent contractors, knowing how this works is necessary for giving informed advice or structuring contracts in a way that is fair.

What Are Estimated Taxes?

The estimated tax return (commonly referred to as a quarterly tax) is what you pay the IRS, if you anticipate owing at least $1,000 in taxes come next year.

While taxes are typically withheld from a regular employee’s paycheck and sent in to the IRS by the employer, that isn’t the case for self-employment (or other types of income like interest, dividends, rent or alimony). These taxpayers make estimated tax payments to help them meet their annual tax liability as they go, rather than take a big hit on April 15th.

Who Must Pay Estimated Taxes?

Knowing who needs to pay quarter taxes is the first step. Generally, you’ll need to pay estimated taxes if you anticipate owing at least $1,000 in federal taxes this tax year in excess of what’s covered by your withholding and refundable credits.

This requirement primarily applies to:

• Self-Employed Individuals and Sole Proprietors: This would be freelancers, independent contractors and people who have a side gig outside of an employer-employee relationship. They have to pay income tax and Self-Employment Tax (Social Security and Medicare).
• Small Business Owners: Owners of LLCs, partnerships, or S-Corporations often have income passed through to them that is not subject to withholding.
• Individuals with Significant Non-Wage Income: This could be supplemental income from investments, dividends, interest, rental properties, or capital gains.
• W-2 Employees with Insufficient Withholding: Even if you have a W-2 job, if you have additional significant income (like a side business) and your employer's withholding isn't enough to cover your total liability, you may need to make estimated payments.

The Underpayment Threshold (Safe Harbor)

You can generally avoid an underpayment penalty if your total tax payments (withholding plus estimated taxes) for the year equal at least the smaller of:

• 90% of the tax you will owe for the current year, OR
• 100% of the tax you owed for the previous year (or 110% if your Adjusted Gross Income (AGI) was over $150,000).

When Are Estimated Taxes Due?

Estimated quarterly tax payments must be made as you earn income. Even though they are colloquially referred to as “quarterly” taxes, the IRS. splits the year into four earning periods that do not perfectly match up with calendar quarters.

Quarterly Due Dates

Note: If a due date falls on a weekend or a legal holiday, the deadline is shifted to the next business day.

Year-End Considerations

The last estimated payment for the prior year’s tax must be sent in by January 15th of the current year. But if you submit your annual tax return (Form 1040) and pay all the tax due by March 1, then the fourth-quarter estimated payment is not necessary.

How to Calculate Estimated Taxes

The IRS provides Form 1040-ES, Estimated Tax for Individuals, which includes a worksheet to help with the calculation. The goal is to estimate your total tax liability for the year and divide it into four timely payments.

1. Estimating Taxable Income

Begin by projecting your total gross income for the year, including self-employment income, wages, interest and dividends received, etc. Next, subtract any anticipated deductions and exemptions to calculate your projected Taxable Income.

2. Calculating Self-Employment Tax

If you are self-employed and your net earnings are $400 or more, you must pay Self-Employment Tax (Social Security and Medicare).

• Self-employment tax is 15.3% of your net earnings (12.4% for Social Security and 2.9% for Medicare).
• The actual math is more complicated - you take your net self-employment earnings (gross income minus the allowable business expenses) and then multiply that by 92.35% to arrive at the amount of your earnings that are hit with the 15.3% Self-Employment Tax.

3. Calculating Income Tax and Total Liability

Use the current year's tax rate schedules (found in Form 1040-ES) to calculate your estimated Income Tax based on your estimated Taxable Income.

Total Estimated Annual Tax = Estimated Income Tax + Estimated Self-Employment Tax

4. Dividing Into Quarterly Payments

The simplest method is to divide your total estimated annual tax by four, resulting in four equal payments.

Quarterly Payment = Total Estimated Annual Tax / 4

Alternatively, if your income fluctuates significantly, you can use the Annualized Income Installment Method (Form 2210) to pay based on the income you actually earned during each period, leading to unequal payments.

How to Pay Estimated Taxes

Payment Methods

The IRS offers several convenient ways to submit your quarterly payments:

• IRS Direct Pay: Make secure payments directly from your bank account (checking or savings) through the IRS website.
• Electronic Federal Tax Payment System (EFTPS): A free service from the U.S. Department of the Treasury that requires prior enrollment. Ideal for making various federal tax payments.
• Debit Card, Credit Card, or Digital Wallet: Payments can be made through third-party processors, who may charge a small fee.
• Check or Money Order: Mailed with Form 1040-ES Payment Voucher to the address specified in the form instructions.

Submitting Payments to the IRS

When making an estimated tax payment, ensure you correctly select the tax year and the type of tax payment (Estimated Tax) to ensure the funds are properly credited to your account. This is vital to accurately applying your payments when you complete your annual tax return.

Consequences of Not Paying Estimated Taxes

Failing to meet your obligation to pay taxes as you earn income can lead to penalties, which is the primary concern for most taxpayers asking “why pay taxes quarterly”.

Penalties and Fees

The most common penalty is the Underpayment of Estimated Tax Penalty. This penalty applies if you did not pay enough tax throughout the year, either through withholding or estimated payments.

The penalty is calculated on Form 2210 and is not a fixed percentage but is based on:

• The amount of the underpayment.
• The period during which the underpayment was due and unpaid.
• The IRS interest rate for underpayments (which changes quarterly).

It is important to remember that even if you receive a refund when you file your annual return, you can still incur a penalty if you failed to make timely and sufficient estimated payments throughout the year.

Impact on Future Tax Returns

An underpayment penalty is resolved at the time you file your annual tax return (Form 1040). It raises your total tax bill, and you have to pay it with any balance that’s still owed. For the self-employed or those with investment income, repeatedly underestimating and underpaying can lead to mounting financial stress and a larger tax bill at year’s end annually; it is not just that we should withhold enough but that we should pay estimated taxes on time in order to plan ahead financially.