The IRS uses a pay-as-you-go income tax system, meaning you must pay your taxes as you earn income. It enforces this by charging penalties for underpayment if you haven't paid enough income taxes through withholding or making quarterly estimated payments. It also charges penalties on late payments even if you get a refund.
The IRS uses a couple of rules to determine if you should make quarterly estimated tax payments:
- You expect to owe more than $1,000 after subtracting withholding and tax credits when filing your return.
- You expect your withholding and tax credits to be less than:
- 90% of your estimated tax liability for the current tax year
- 100% of the previous year's tax liability, assuming it covers all 12 months of the calendar year
The tax code calls this last item the safe harbor rule. This requirement increases to 110% of your adjusted gross income exceeds $150,000 ($75,000, if you're married and file separately).
One exception applies for farmers and fishers who earn at least 66.6% of their income from their trades and so only need to meet an equivalent amount of their tax liability.
Paying your taxes quarterly can also avoid the cash crunch you might face come tax time. Paying in quarterly installments makes paying your bill far easier than one lump sum payment, especially if you've underestimated your taxes due.
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