Question

As an employee, we taxes are withheld by the employer and submitted to the appropriate tax government agency (i.e. IRS) on your behalf.

Technically, an employee does not need to worry about making estimated payments to avoid an underpayment penalty as long as the W-4 is properly and correctly completed.

What are some reasons where an employee needs to make estimated payments?

Answer 1

Underpaying your taxes won't always result in an actual penalty. Generally, you can avoid an underpayment penalty in the following scenarios:

• You owe less than $1,000 in taxes after subtracting your withholdings and estimated tax payments
• You had no tax liability the previous year
• You paid at least 90% of the tax you owed for the current year, or 100% of what you paid in taxes the previous year -- whichever is smaller

That last rule, however, works a bit differently for higher earners. If your adjusted gross income for the previous year is over $150,000 as a married couple filing jointly, or over $75,000 as a single filer or couple filing separately, you're required to pay 90% of the current year's tax bill or 110% of the previous year's tax bill -- whichever figure is lower. You should also note that the rules regarding underpayment penalties are different for farmers and fishermen.

Income tax in the United States works on a pay-as-you-go system and so the federal government collects income taxes throughout the year via payroll taxes. When you file your tax return — by the April deadline — ideally you have already paid all of your taxes. Most people overpay throughout the year, which is why they get a tax refund from the IRS. If you underpay, you will face a bill when you file your return.

However, not everyone has an employer to withhold taxes. Small-business owners, self-employed individuals, and workers who receive a 1099 instead of a W-2 still have to make tax payments throughout the year. They do so with quarterly estimated tax payments.

The basic process for paying estimated taxes is to calculate how much tax you will need to pay over the year (also known as your tax liability), divide that number by four to find your quarterly tax payments, and then make the payments on time. If your income varies throughout the year or if your expected income changes, you may need to recalculate each quarter. Come tax season, you still file a regular tax return.