Tuesday, January 14, 2014
Tax Tip - Estimated Payments
For the past 16 years I have worked as a seasonal tax pro, preparing individual tax returns. I am an IRS Enrolled Agent (EA), which simply means I passed a two-day comprehensive exam on tax law (34% first time pass rate back in the day), and I am allowed to represent tax clients in audits all the way to the Tax Court level, if necessary. There are strict mandatory continuing education requirements and ethical standards that one must meet in order to retain EA status.
So, during this tax season, I'll be sharing some of what I've learned over the years by offering occasional tax tips on the blog.
Today I'll be discussing Estimated Payments. If you were making estimated payments for Tax Year 2013, your 4th quarterly payment is due January 15, 2014, so this seemed like a timely post for my USA readers.
What Is Estimated Tax?
Estimated tax is a way to pay tax on income that is not subject to withholding --basically, any income other than wages reported on a W-2. (Although unemployment benefits, Social Security benefits, and pensions and annuities (1099-R) allow recipients to elect withholding).
Since Etsy shop owners are self-employed, that income is not subject to withholding, and you may want to consider making estimated payments. (Self-employment income is also be subject to SE Tax, which means you pay both your individual share and your employer's share (YOU are your employer) of Social Security and Medicare taxes on 92% of your self-employment income. That's roughly another 15% added to your tax bill. Yikes!!
SO-- Let's say you net $5,000.00 in Etsy sales, and your other income pushes you into the 15% tax bracket. You could owe 15% in income tax, plus approximately 15% in SE tax on that 92% of that income -- roughly $1500. Ouch!
Why Make Estimated Payments?
Since the U.S. tax system is a "pay-as-you-go" system, if you wait until April 15 to pay all of your balance due, you may be subject to penalties. Estimated payments are a way to avoid the risk of penalty, and to avoid the unpleasant shock of a big balance due.
So, instead of scrambling to come up with an extra $1500 on April 15, you could pay four quarterly payments of $375 -- OR, because most Etsy sellers have an income surge in the 4th quarter, you could make smaller estimated payments for the first 3 quarters, and a bigger estimated payment in the 4th quarter.
Why NOT Make Estimated Payments
There are certain situations where there is really no need to make estimated payments:
If you expect to owe less than $1,000.00 in tax after subtracting withholding from your day job and refundable credits. Refundable credits generally apply to lower income taxpayers with children and to undergraduate students who are not claimed as dependents on their parents' tax return. Earned income credit, additional child tax credit, and a portion of the American Opportunity Credit are refundable credits.
If you increase your withholding on your W-2 income in lieu of making estimated payments.
Let's say you expect to owe $1500.00 in taxes on your self-employment income. If you are paid weekly at your day job you could have an extra $30 taken out of each paycheck and you'd cover that tax and have a little cushion. If you are paid bi-weekly (every two weeks) you could have an extra $58 to $60 taken out of each paycheck. You can request additional withholding by submitting a Form W-4 to your payroll office at work. Simply complete that form and write the additional amount you would like withheld on Line 6. Easy peasy lemon squeezy.
When Are Estimated Taxes Due?
Although I've referred to the payments as quarterly payments, the due dates are not spaced 3 months apart. So if you plan to make ES payments for tax year 2014, print off the vouchers, preaddress your envelopes, create an Estimated Payments file folder, and mark these dates on your calendar:
April 15 (double ouch)
For more information, consult IRS Pub 505 - Tax Withholding and Estimated Tax, or ask your friendly tax professional.
Disclaimer: I do not claim to be a tax expert. The general information provided is not personalized tax advice -- individual situations may vary. The views expressed are my own, and not necessarily those of my employer.