The federal income tax system is a pay-as-you-go system. In other words, instead of paying your entire tax bill when you file your return, you pay your taxes in smaller payments throughout the year.

The pay-as-you-go system is the reason that employers withhold money from the paychecks of their employees (and then hand that money over to the federal government).

Thus, if you are an employee, you don’t have to work too hard to figure out the pay-as-you-go system (as long as you correctly filled out your Form W-4 when you started your job). Your employer will take care of the payments for you.

However, if you are self-employed (or if you are an employee but have other sources of income), you must administer the pay-as-you-go system yourself.

You do so by paying quarterly estimated taxes.

Who Has to Pay

You probably have to pay quarterly estimated taxes if you have income from any of the following sources:

• Income from self-employment
• Compensation as an independent contractor
• Gains from the sale of stock or other property
• Royalties
• Interest
• Dividends
• Awards
• Any other income for which tax is not withheld

$1,000 Minimum

You have to pay estimated taxes only if you owe $1,000 or more of tax at the end of the year in excess of what you have paid through employee withholding.¹

Example. Suppose you owe $12,000 in taxes at the end of the year, and you have already paid $10,000 through withholding (and $0 in estimated taxes). Because your tax liability is $2,000 greater than what you paid, you will face penalties for your failure to pay estimated taxes.

Deadlines

You have to pay estimated tax four times a year, and you will face penalties if you do not pay a sufficient amount by each deadline.²

The deadlines occur 15 days after the end of each quarter. How long is a quarter? Three months? No.

The tax authorities decided to create four quarters of unequal length.

The payment deadlines are as follows (the dates for calendar year taxpayers are written in bold):³

• Quarter 1: 15th day of the fourth month (April 15)
• Quarter 2: 15th day of the sixth month (June 15)
• Quarter 3: 15th day of the ninth month (September 15)
• Quarter 4: 15th day of the first month of the next year (January 15 of the following year)

Note that if the 15th falls on a Saturday, Sunday, or a holiday, your deadline is the first business day after that Saturday, Sunday, or holiday.⁴

Minimum Amount

To determine how much you must pay each quarter, you can use either of the following methods (see more on these in the next sections):

1. Pay a percentage of your predicted income for the current year
2. Pay a higher percentage of the previous year’s income

Remember that withholding counts as estimated tax for this purpose.⁵ Thus, if you work as an employee in one job and have your own business, you take your withheld income into account when determining your estimated payments.

Predict Your Income for the Current Year

Under the first method, you can avoid penalties if you pay at least 22.5 percent of the amount of tax you will ultimately owe for that year.⁶

Thus, under this rule, if you want to calculate the correct minimum amount for each quarterly payment, you must:

1. Determine how much you will owe at the end of the year, and
2. Pay 22.5 percent of that amount each quarter.

If you use this method and you have unpredictable income, the safest course of action is to overpay. You can get a refund of your overpayments at the end of the year, or you can apply the overpayments to next year’s estimated taxes.⁷

Use the Previous Year as a Guide

Under your second alternative, you can base your estimated tax payments on the total tax you owed for the previous year.

With this method, you make quarterly payments of at least 25 percent of the amount of tax you owed for the previous tax year.⁸ (27.5 percent if you earned $150,000 or more during the previous year.⁹)

1. IRC Section 6654(e)(1).
2. IRC Section 6654(a).
3. IRC Sections 6654(c)(2), (k)(1).
4. IRS Publication 505, Tax Withholding and Estimated Tax, published April 8, 2013, p. 28.
5. IRC Section 6654(g)(1). You treat the withheld payments as if you paid them in equal amounts for each quarter.
6. IRC Section 6654(d)(1)(B)(i) (quarterly payments must be 25 percent of 90 percent of year’s tax (25% x 90% = 22.5%). You can change the percentage due at each quarter if you annualize your income. IRC Section 6654(d)(2).
7. IRC Section 6402(b); Reg. Section 301.6402-3(a)(5).
8. IRC Section 6654(d)(1)(B)(ii).
9. IRC Section 6654(d)(1)(C).

• By Leon Clinton
• May 22, 2023

You need an estate plan, regardless of whether or not you are among the ultra-rich. As recent news has shown, even those who have won the lottery or have substantial wealth can fall victim to poor estate planning.

While federal estate taxes may not concern you, you need a will to have your wishes honored after your death. Without a will, state law dictates the distribution of your assets, which may not align with your intentions. Additionally, if you have minor children, a will allows you to name a guardian to care for them in the event of your untimely passing.

Your heirs will want to avoid probate because it can be a costly and time-consuming legal process. A living trust gives you a valuable tool to avoid probate. By transferring legal ownership of your assets to the trust, you can ensure that your beneficiaries receive them without suffering through probate.

You can amend your living trust as circumstances change, providing flexibility and control over your assets.

It is also essential to keep your beneficiary designations up-to-date, as they take precedence over wills and living trusts regarding asset distribution.

Additionally, if your estate will suffer from federal or state death taxes, you should plan to minimize your exposure.

Estate planning is not a one-time event but a process that you should review and update regularly to accommodate life changes and fluctuations in estate and death tax rules. We recommend checking your estate plan annually to ensure it aligns with your wishes and circumstances.

If you have any questions or concerns about estate planning, please do not hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• May 17, 2023

When your S corporation covers or reimburses your more-than-2-percent-shareholder-employee health insurance expenses, it classifies the payments as box 1 W-2 wages but not box 3 or box 5 wages.

When calculating the amount eligible for the Form 1040 self-employed health insurance deduction, you must use your Medicare wages (listed in box 5 of Form W-2) as your “earned income” rather than the amount reported in box 1.

Here are two examples that show you the impact of this rule:

• Ted’s S corporation pays him $0 in cash wages and reimburses him $18,000 for health insurance. His W-2 shows $18,000 as box 1 wages and $0 as box 3 and box 5 wages. Although Ted has $18,000 in taxable wage income from the corporation’s reimbursement of his health insurance, his Form 1040 self-employed health insurance deduction is $0 due to his lack of Medicare wages.
• Janet’s corporation pays her $107,000 in cash wages and reimburses her $22,000 for health insurance. Janet’s W-2 from her S corporation shows box 1 wages of $129,000, box 3 wages of $107,000, and box 5 wages of $107,000. The IRS allows her Form 1040 self-employed health insurance deduction of $22,000 because her Medicare wages exceed the insurance cost.

To avoid unfavorable tax outcomes, ensure that your S corporation reports Medicare wages (box 5) equal to or greater than the health insurance costs paid or reimbursed.

Please call me on my direct line at 408-778-9651 if you have questions or need additional clarification on this rule and how it may affect your tax situation.

• By Leon Clinton
• May 12, 2023