Paying only when you earnA large estimated tax bill can take a big bite out of even a wealthier earner's wallet, in spite of being spread out in four payments.
But the tax pain can be postponed, if not avoided.
Although the IRS will always take your money early, you don't have to make estimated tax payments until you have income on which you will owe the tax.
If most of your untaxed income comes in one quarter (such as stock dividends paid at year's end) or if you operate a business where income fluctuates throughout the year, you should consider paying your estimated taxes under the annualized income system.
"The annualized method allows you to take a look at each quarter independently and pay the tax in the quarter that you earned it," says Durand. "Say your job is one where most income is in the summer, such as landscaping, rather than the winter; you want to pay the taxes when you have the money."
With this approach, your required estimated tax payment for one or more periods might be less than the amount figured using the four-equal-payments method. To find that out, you'll have to complete a work sheet, found in IRS Publication 505, Tax Withholding and Estimated Tax. Sole proprietors need another work sheet found in IRS Publication 505 to determine annualized self-employment taxes that are included with the estimated payments.
And you'll need to file Form 2210 with your annual return to explain why you didn't send in the expected equal payments, says Durand. This will keep the IRS, which assumes you earned the money equally during the year, from charging you an underpayment penalty and interest for not paying enough in a particular filing quarter.
"It is a little more complicated," Durand says. "But for cash flow, it's better, and it puts the tax in the quarter when it is earned."
A way to avoid estimated filingDoes the prospect of struggling through work sheets and filing even more tax returns make your head spin? There is an alternative.
If you have wage income in addition to untaxed earnings, file a new W-4 at work and ask your boss to start taking out more payroll taxes to cover any shortfall. This strategy also works for couples who file jointly, but where only one spouse has wage income subject to withholding.
Your take-home pay will be a bit lighter, but you'll be off the hook for estimated tax payments.
But if you make the withholding change now rather than waiting until the very end of the year, the per-check tax bite won't be as big since it will be spread over four months.
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