Pay Estimated Taxes! Adhesive Note Reminder
It is tax time and your accountant is not only telling you how much you owe for last year’s taxes but also breaking the news that you must pay estimated taxes for the current year. Those pesky estimated taxes are due the middle of every April, June, September, and January. If you forget to make a payment, then you also pay a nasty little fine. Is there a way around making estimated tax payments so you don’t have to worry about timing and potential fines? It depends.
There are three main categories of how people pay federal taxes:
· Most people pay their taxes through withholding at their job. There are situations where the withholding from work isn’t enough to cover the tax bill, such as when your spouse works and the combined income bumps you into a higher tax bracket or if you have additional income being kicked off from investments.
· If you are retired and have income from various sources such as an IRA and taxable investment income, you can pay quarterly estimated taxes or withhold taxes from your IRA, retirement plan, or social security distributions.
· If you are self-employed and don’t have W2 wages or retirement plan distributions, there is no way around paying estimated taxes.
If you are working and have investment income causing the need for additional tax payments or if you and your spouse makes combined income that bumps you in a higher tax bracket, the IRS has a nifty tax withholding calculator that estimates your current taxes based on a series of questions and provides a prefilled W-4 that you can give to your employer to change your tax withholding. It is super easy. You can change your withholding any time of year to cover unexpected investment income.
If you are retired and your income comes from retirement plans, social security, and pensions, the IRS calculator won’t work. You’ll either need the help of an accountant or use another tool to estimate your income and taxes due. Turbotax and others have free quick and dirty tax calculators for the prior year’s taxes that can help you estimate what you will owe for the current year’s taxes. These require you to enter your income estimates but thankfully don’t require any personal data.
For example, if you plan to make $40,000 in IRA distributions and have $20,000 in social security income with the standard deduction, your taxes owed will be about $4,736 using the 2023 calculator. You have a choice – use your cash flow to pay quarterly estimates of $1,184 or when you do your IRA distribution, elect 12% withholding for federal taxes on your $40,000 IRA distribution. It is much easier to do the withholding on the IRA distribution than remembering to pay quarterly estimates.
The best part of paying your tax through withholding on the IRA distribution? The timing does not matter. You can wait and do your distribution in December so your money can continue to earn interest throughout the year. Don’t give your money to the IRS early if it isn’t required!
Just a reminder - since you are planning for the current year, the taxes will be a little bit different with tax bracket and standard deduction inflation adjustments, but the prior year calculator will be enough to get you close. It is rare for tax estimates to be exactly on the dollar.
If your tax picture is complicated, and especially if you are self-employed, an accountant is invaluable and can do a much better job with the estimates. Make sure to ask them if it is better to do withholding adjustments instead of paying quarterly estimates. Many accountants just kick out the quarterly estimated tax forms as standard procedure and forget to tell you that you can pay your taxes in other ways.
Taxes are no fun, and remembering to pay estimates every quarter is a pain. With good planning, you can save time and money by adjusting your tax withholding instead of sticking those quarterly checks in the mail.
