Do you owe the IRS an estimated tax payment?
Most Americans have income taxes withheld from their paychecks and their employer sends the tax payment to the IRS on their behalf. But if the payments don’t cover your taxes at the end of the year, and you want to avoid penalties, you must make estimated payments to the IRS on a quarterly basis. This year, because of the extension of the filing date due to Covid 19, the first two payments are due on July 15th
Who needs to pay now
You may need to make a payment if one of the following situations applies to you:
- Paychecks are under-withheld. Your employer withholds a portion of your paychecks for income tax purposes, then submits a payment to the IRS on your behalf based on how you filled out your W-9 form. The amount that is withheld from your paychecks, however, may not cover your entire tax liability, resulting in you needing to write the IRS a check. If you’re not withholding enough, ask your employer to increase the withholding amount from your future paychecks so you don’t come up short again in the future.
- Unemployment compensation paychecks are under-withheld. Unemployment compensation is subject to federal income tax and subject to income taxes in several states. While some unemployment benefit checks withhold a percentage of your payment for income tax purposes, you may need to pay more in taxes than is being withheld.
- Self-employed workers. Unlike employees, self-employed workers don’t have income tax withheld from pay and must make four estimated tax payments over a period of 12 months. Self-employed workers include gig economy workers, freelancers, S corporation shareholders and partners in a partnership. Self-employed workers may owe more because of self-employment taxes that are included in the calculation.
- You may owe tax on Social Security benefits, as well as income from investments distributed to you or other unearned income. A portion of pension plan distributions may be withheld, but many times the amount withheld does not cover your entire tax liability, resulting in an underpayment.
- Sold a major asset. You may owe tax after selling an asset that results in a large capital gain, such as a house, or from the sale of securities.
- Receive alimony. If you’re being paid alimony under a divorce decree entered into before 2019, the payments constitute taxable income to you. Alimony from post-2018 agreements, however, are not taxable.
What you need to do
Estimate your total income for 2020, then calculate your total 2020 tax bill and divide it by 2. Compare this amount to how much has been withheld from your paychecks, unemployment benefits and any other payments you’ve made to the IRS through the end of June. If you’re short, consider making an estimated payment by July 15 to make up the difference. This payment is made with Form 1040-ES.
If you do not make this payment on time, the IRS may impose a penalty plus interest on top of the underpaid taxes. Fortunately, you can avoid a penalty by paying at least 90% of the current year’s tax liability or 100% of the prior year’s tax liability (110% if your adjusted gross income for the prior year exceeds $150,000). And don’t forget if you live or work in a state that has income tax, you may need to make payments to that state as well.
No one likes surprises when they do their taxes the following year. We’d love to do a tax projection to see if you are on track for 2020 with your payments.