Friday, April 17, 2009

Are You Required to Make Estimated Tax Payments?

Few things are more confounding to taxpayers than estimated tax payments. Moreover, few things get taxpayers into more trouble.

Estimated tax payments are supposed to be made quarterly by any taxpayer whose taxes aren’t withheld from their income. If you work for a company and they withhold taxes for you, including Medicare and Social Security, then you probably don’t have to make quarterly payments. But, if you also do some other work on the side, like selling Avon or doing freelance work, you are required to pay taxes on that income.

If you are an independently contracted worker, or self-employed, then you need to pay income and Social Security taxes on your income. How much you will pay depends on how much you make and your general tax situation. A good estimation is to take a look at your most recent tax return. Take your total tax liability and add 15% to account for Social Security and Medicare taxes. If you predict having similar income and deductions this year, then you can take the total tax liability, divide it by four, and that’s your estimated quarterly payment.

Making these payments may seem like a hassle, but as I mentioned, not making these payments gets so many taxpayers in trouble with the IRS. If you don’t make them, the IRS may penalize you at tax time, or you might be saddled with more tax liability than you have the ability to pay. Just think about it, if your total tax liability for a year is $5,000, paying it all at once is probably going to hurt. But planning ahead and paying $1,250 every quarter is probably more manageable. Alternatively, you can make monthly payments, if that is easier for you. Simply divide your total tax liability by 12.

Small business owners have historically failed to make accurate and timely tax payments. The IRS figured this out and now heavily scrutinizes any self-employed people and small-business owner tax returns. This can lead to audits, penalties and enormous tax debts. From my experience, this is one of the top reasons people get in debt to the IRS. And in this case, an ounce of prevention is worth a pound of cure.

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