Warning in advance: whatever questions you might have about estimated taxes, there are no satisfying answers! There’s a reason they’re called “estimated”; you’re just throwing numbers in the general vicinity of an imprecise target and hoping for the best.
That said, there are three questions people typically ask:
- Do I need to pay estimated taxes?
- How do I pay estimated taxes?
- How much should I pay?
If, having read that, you’re feeling a bit overwhelmed, here are some things to consider – though I apologize in advance if this does nothing but add to the confusion!:
- Do I need to pay estimated taxes? You don’t need to make quarterly estimated tax payments if you’re ok with paying the associated “penalty” at tax time. It’s not truly a “penalty”, though; it’s just the IRS charging you interest, an amount which depends on 1) the current interest rate environment (the IRS rate is currently around 1.5% per quarter, as of early 2019) and 2) a weirdly complicated calculation of the quarterly underpaid balance to which that interest rate applies. So do you “need” to pay estimated taxes? No. Should you? Maybe, but that’s up to you and your particular relationship with your own money and the IRS. Some of my clients pay all of their taxes in one lump sum by April 15th, swallow any associated interest charge/penalty, and call it good. They’re able to use those funds, and earn interest or dividends or whatever, up until the date they cut that check to the IRS. It’s a totally defensible strategy; just be sure you have the funds saved up to pay off the full balance at tax time.
- How do I pay estimated taxes? You’d think you could set up some kind of monthly recurring payment, wouldn’t you? If you can figure out how to do that, let me know. For now, we’re stuck with this inane quarterly system … which isn’t even exactly quarterly, since payment due dates are sometimes 2, sometimes 3, and sometimes 4 months apart. (I’m not making this up.) You can pay by check, or pay electronically here. For Oregon, electronic payments can be made here, but be warned that it’s not an intuitive experience.
- How much should I pay? There’s no definite answer to this. It depends on your particular tax history, and what you’re trying to achieve or avoid. Different people with exactly the same tax situation might reasonably choose to pay different amounts; there’s no absolute-right-or-wrong answer. If you’re trying to avoid the “penalty” mentioned above, the simplest way is to take your tax liability for the prior year, divide by 4, and make sure your total withholding and estimated tax payments for the current year are at least 110% of that amount. This should ensure that you avoid any interest charge, but won’t in any way guarantee that you don’t end up owing a lot when tax time comes around. If instead your goal is to cover your full tax liability, then a reasonable approach would be to pay a fixed percentage* of your quarterly self-employment income, rental income, etc. If you do that, it’s less likely you’ll owe a lot at tax time, though you’re then taking on the risk of overpaying (and foregoing investment earnings) or underpaying (and facing an interest charge). And the appropriate “fixed” percentage is going to vary from person to person, year to year, tax return to tax return. Not only is it not easy to calculate in advance, it’s not possible to calculate in advance with any precision.
There’s no tax form, other than a payment voucher if you’re mailing a check (see here and here)**, that goes along with your estimated tax payment. You’re simply sending money to the IRS and Oregon. You’re not reporting your quarterly income, or anything like that. Make the payments, keep a record of the dates and amounts paid, claim them as amounts previously paid when you file your tax return next year, and that’s it.
*(A typical amount might be 25% of your un-taxed income towards federal taxes, and 8% to Oregon. Those numbers will often put you in the right ballpark, but they can certainly be too high or too low by a significant amount. If you’re in a high tax bracket, you might want to up it to 35%/9%. If you’re in a lower tax bracket, you might get by with something like 18%/7%)
**(Depending on when I last updated those links, they may point to the wrong tax year. A quick Google search should pull up the right form, in that case. It’s a 1040-ES for federal, and a, OR-40-V for Oregon.)