We all know that all taxpayers must pay taxes on the income they receive. However, the IRS has made your life more difficult by requiring taxes on your income to essentially be prepaid, usually quarterly. In addition, more than 10 million taxpayers are subject to an estimated tax penalty each year because they did not make enough tax prepayment. In this article, we will explain what the estimated tax is, who needs to pay it, and how to pay it.
What is estimated tax?
The “estimated tax” is usually a quarterly tax payment a taxpayer needs to make. The IRS invented this concept to make sure they have tax revenue stream throughout the current year as opposed to receiving one lump sum of tax revenue in the following year. This idea is not new -- just think about how renters pay rent each month rather than making one payment at the end of the year.
So who needs to pay estimated tax?
Now you may be thinking, “I have never made these quarterly estimated tax payments since I only pay tax (or get a refund) once a year and am I one of the unlucky taxpayers who might be subject to penalties?"
Well, don’t panic. If you only receive W-2 salaries and wages, you are probably fine because your employer usually withholds a good amount of tax for you. In other words, a portion of your monthly income has already been withheld and paid to IRS before the rest reaches your bank account.
That being said, one possible exception is if you work in a tech company and receive stock compensation, then this issue could be more complex. For example, let’s say your base salary is $100k cash and you also have $900k of vested RSU in your W-2. Most employers put a flat withholding rate of 22% on “supplemental wages”, which includes stock awards and bonuses that are less than $1 million (if it is more than $1 million, the withholding rate of the excess amount increases to 37%). 22% withholding rate is probably not enough because high earners usually have a marginal tax rate above 40%. If you don’t make additional estimated tax payments each quarter in addition to the amount withheld in your W-2, then you could be subject to estimated tax penalties.
Additionally, if you are a sole proprietor, partner, or S corp shareholder, you will most likely need to make quarterly estimated tax payments because no one withholds tax for you.
How much estimated tax do I need to pay to avoid tax penalties?
So how do you know if you paid enough estimated tax to avoid penalties? There are a couple of ways to determine whether you have paid enough estimated tax:
(1) Always pay at least 90% of your current year estimated tax liability; or
(2) Pay 100% of last year’s actual tax liability (or if you file jointly and your AGI was at least $150,000 last year, then pay 110% of last year’s tax liability to avoid a penalty). This second approach is also called the safe harbor rule.
If you file your own tax return using TurboTax and you owe taxes to IRS, you must have noticed something called “payment voucher” at the front of your federal and state tax returns as seen below.
Turbo tax calculates this estimated tax based on the safe harbor rule and generates these vouchers for you to pay your estimated tax in the upcoming year. You may begin your estimate tax payment journey from these vouchers. Good luck!
Here are the due dates for 2022 estimated tax payments:
How do I pay federal estimated tax?
To pay your federal estimated tax, go to https://www.irs.gov/payments.
There are multiple payment selections in the web page. Many people choose “Pay Your Bank Account” (Direct Pay) because it is free.
If you choose direct pay with a bank account, you will be directed to the page below. Select “Make a payment”.
In “Reason for Payment” dropdown menu, select “Estimated Tax”.
From here, you just need to follow the steps to make the payment. Make sure you have your prior year’s tax return on hand for identity verification. Please do remember to save the confirmation after the payment is made.
How do I pay estimated tax to New Jersey State?
To pay your New Jersey estimated tax, go to https://www1.state.nj.us/TYTR_RevTaxPortal/jsp/IndTaxLoginJsp.jsp
Enter your SSN and DOB on this page, then click “Submit”
After your pass the identity verification, select “Estimated Payments – Schedule/Submit NJ-1040-ES” then click “Submit”.
Then you can choose to schedule multiple payments or a single payment.
You just need to follow the instructions and use your bank account or credit card information to complete the payment next. Remember to save the confirmation after the payment is made!
If you live in another state other than NJ, the process is similar.
Pay New York State Estimated Tax: https://www.tax.ny.gov/pay/ind/pay-income-tax-online.htm
Pay California Estimated Tax: https://www.ftb.ca.gov/pay/bank-account/index.asp
Pay Massachusetts Estimated Tax: https://mtc.dor.state.ma.us/mtc/_/
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
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