Determine the Type of Income You Have
To determine how to calculate your estimated tax payments, first we need to know what kind of income you have. The two main categories of income for estimated tax are income not subject to self-employment tax and income that is subject to self-employment tax.
An important thing to remember is that we are making an “estimate” based on what we know. The true amount owed will reconcile on your tax return. This means that you may be underpaid or overpaid when the return is calculated. The idea is to get a close to the tax owed as possible, so be as accurate as possible.
Income that is not from self-employment
Let’s start with income that is not subject to self-employment tax… Wages. Winnings. Interest. Capital gains. Passive income which includes dividends, interest, rental income, and other income from pass-through entities (you may get a form K1). Most of these come to you without having tax withheld. Maybe you just don’t have enough withheld from your paychecks. Maybe you sold stock or some land. Or maybe you have a rental property that actually produces income. All these are added to your taxable income and if the income is significant, you could be looking at writing a big, fat check in April, and possibly being subject to penalties for underestimating your taxes. Yes, we are a “pay-as-you-go” tax society. To make the country run, the USA depends on the regular income of our paid-in taxes.
The simplest way to calculate the recommended estimated tax is to take a look at your total tax from the previous year’s return. This is not the amount you “wrote on the check.” On the 2020 Form 1040, that line number is line 24. (With all the recent changes in the tax forms the last three years, line numbers are a moving target. Look for the words “total tax.”)
Now, think about your current situation. Are you making more money this year? Are you making less? Did you sell a large block of stock? Did you take a larger retirement distribution than you took last year? How have things changed? This is why it is called an “ESTIMATE.” We are trying to get as close to the total tax figure as we can.
Take the increased amount of income and multiply it by your tax bracket percentage. If you can’t find this on a page included in your tax return, see this page. (For clients of First City Income Tax, your “Comparison Page” shows your tax bracket for the past three years at the bottom of the page. It is your marginal tax rate.) Subtract the amount of estimated withholding from your paycheck this year. The resulting figure is close to the amount you would need to pay in addition to what is currently being withheld.
- Estimate your increased income
- Multiply that increase by your tax bracket (or the next one up depending on the amount)
- Add that increased tax to your total tax for last year
- Subtract your withholding from your paychecks for this year, and credits for which you qualify (Look for the credits on the bottom of page two of your 1040.)
- The resulting figure should be an estimated amount of additional tax you should pay.
Go to the IRS website and choose “Make a Payment” from the eight banners at the top of the page. And make your estimated payment choosing “Estimated Tax” from the pull-down when asked for a reason you are making the payment.
For those of us living in Georgia, go to the Georgia Tax Center and choose to “Make a Quick Payment” and follow the prompts. GA tax for 2021 should be estimated at 5.5%.
If you are self-employed, start with your gross receipts for the quarter. Subtract a quick assessment of your allowable business expenses for the quarter. The resulting amount is your tentative net profit. The net profit from self-employment is subject to regular federal income tax at your tax rate, self-employment tax, and state tax. Determine your tax bracket as we did above. (Remember that the tax brackets are based on the whole year and we are dealing with only one quarter at a time.) This tax is only part of your estimated payment. The net profit is also subject to self-employment tax which is 15.3% (with a few adjustments). So take the net profit, multiply that by .153 and add the resulting figure to the federal tax figure you had from the previous maneuver. State tax for GA should be 5.5%.
If you need help determining the allowable business expenses, check out the IRS website about Schedule C. You can also call our office at First City Income Tax. It is imperative that you use solid, reliable bookkeeping practices. Paper ledgers work, but software such as Quickbooks make keeping your books easier. Software allows you to run a profit and loss report. This is a good place to retrieve your estimated net profit figure. If you are interested in Quickbooks, call our office. We can also keep your books for you.
- Add up the gross receipts for the quarter
- Subtract the total estimated allowable business expenses for the quarter
- Now you have the estimated net profit
- Multiply that net profit by your tax bracket percentage
- Now multiply that net profit number by .153
- Add those two figures together and there is your Federal estimate for the quarter
- Multiply the net profit again by .055 and there is your GA estimate
Take a note that the quarters according to the IRS are not actually every three months. The estimated taxes are due as follows:
- April 15 (yes, the same day as your taxes from last year)
- June 15 (see, only two months later)
- September 15
- January 15
Be careful to note the proper tax year you want the IRS to attribute to the payments. Clients sometimes confuse the April 15 payment with their tax payment for the previous year, and as well, the January 15 payment with tax payment for the following year. I know we are all trying to get away from paper, but it is a good idea to write down the amounts and dates of each payment. You need this information when you file the tax return.
Our office is available for consult, and as well, we offer a range of tax preparation, bookkeeping, and tax resolution services. Call us.
Keep checking back with us. Soon we will present a series on Self-employment Taxes.
If you want more info on estimated tax, check out this blog post.
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