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How to Calculate and Pay Your Estimated Individual Income Taxes

How to Calculate and Pay Your Estimated Income Taxes

How to Calculate and Pay Your Estimated Individual Income Taxes

It’s mid-February and you’ve finally managed to gather all of your tax data and send it in to your accountant. You know you had a small refund the prior year and that you received approximately the same amount of income this year, which is why you’re so surprised when you learn that you owe a few thousand dollars between your Federal and State tax returns. Not only that, but you have interest and penalties to pay as well. How could this have happened, and what steps do you need to take to prevent it from happening in the future?

A pattern I’ve noticed with my clients is that, often, when one receives a refund, they feel they got a “good deal” on their taxes for the year, and when they owe money, they think they’ve received a “bad deal,” that there must be some mistake or some change to the tax law that is out of their favor. While possible, more often than not what changed is the taxpayer’s situation. Consider the following:

  • You decided to start a side hustle during 2020 to help make up for some lost income when your job shut down during the beginning of COVID. You didn’t make much that first year, but the business has since taken off and you’ve increased your revenue substantially. You generally get a decent refund, so you expected you would have enough paid in to cover any taxes related to the income – not realizing that since you are your own employer for that business, you owe the employer’s portion of Social Security and Medicare taxes as well, increasing your liability by 7.65% of the earnings.
  • You’ve held the same W-2 job for the last 5 years but decided to switch to a company that paid you as an independent contractor via Form 1099 towards the end of the year. Your income was substantially the same, but you forgot that taxes were no longer being withheld from your income you earned once you started your new job.
  • You have four children who you claim a Child Tax Credit for. Due to the size of the credit you receive, you previously instructed your employer to reduce your withholding. Two children, twins, turned 18 during the tax year. You can still claim them as a dependent, but the credit has now reduced for each of them from $3,000 to $500.

When a life change occurs, a taxpayer’s first thought is generally not to call and discuss with their CPA, and it’s easy to see how certain situations may not seem to necessitate any action at all. However, it’s never a bad idea to check in mid-year and discuss whether any estimated tax payments may need to be made.

What are estimated tax payments and how do I calculate them?

An estimated tax payment is a method of paying taxes to the Federal or State government on income not subject to withholding.  This income typically includes investment income such as interest, dividends and capital gains, and earnings from self-employment, including independent contractor work. These payments are made with Federal Form 1040-ES, Estimated Payment Voucher, or with a state’s respective form.

In order to calculate the amount that will be due, a taxpayer must have an understanding of their situation and the tax rules and rates applicable to them, or have an accountant that can assist them with the process. Not only are income tax brackets marginal, meaning that different “tiers” of ordinary income are taxed at different rates, but different types of income may be taxed at different rates as well. Throw in various credits and deductions, and the projection process can become rather complicated.

If attempting to compute on your own, the easiest and most conservative ways, respectively, would be to use a calculator available online, or to multiply the amount of income received by the tax rate corresponding to the income’s bracket and character, and pay in this amount. Brackets for the 2022 tax year are as follows:

 

INDIVIDUAL INCOME TAX BRACKETS

Tax Rate Single/Married Filing Separate Married Filing Joint Head of Household
10% $0 – $10,275 $0 – $20.550 $0 – $14,650
12% $10,275 – $41,775 $20,550 – $83,550 $14,650 – $55,900
22% $41,775 – $89,075 $83,550 – $178,150 $55,900 – $89,050
24% $89,075 – $170,050 $178,150 – $340,100 $89,050 – $170,050
32% $170,050 – $215,950 $340,100 – $431,900 $170,050 – $215,950
35% $215,950 – 539,900 $431,900 – $647,850 $215,950 – $539,900
37% $539,900 + $647,850 + $539,900 +

 

CAPITAL GAINS TAX BRACKETS

Tax Rate Single/Married Filing Separate Married Filing Joint Head of Household
0% $0 – $41,675 $0 – $83,350 $0 – $55,800
15% $41,675 – $459,750 $83,350 – $517,200 $55,800 – $488,500
20% $459,750 + $517,200 + $488,500 +

 

How do I make estimated tax payments?

Individuals may make Federal estimated tax payments and payments due with Form 1040 online, by phone, by mail or in person with cash, a check, a money order, a bank transfer, or a debit/credit card, depending on the method chosen. See Instructions for Form 1040-ES, pages 3-5 for steps on how to pay via the method you choose.

Methods for making State estimated income tax payments will vary, but for Michigan, they are made with Form MI-1040ES, Michigan Estimated Individual Income Tax Voucher, online or by mail with a check, bank transfer or debit/credit card. To pay online, access https://www.michigan.gov/taxes/iit, select “Pay Your Taxes Online” and follow the instructions. To mail your payment, make a check payable to “State of Michigan” and print the last four digits of your SSN and “20XX MI-1040ES” on the check (replacing the X’s with the correct year). If paying on behalf of another taxpayer, write his or her name and last four digits of their SSN on the check. Do not combine this payment with any others. Be sure to include the completed payment voucher with your check. It should be mailed to: Michigan Department of Treasury, P.O. Box 30774, Lansing, MI 48909.

Due dates for Federal and most State individual estimated income tax payments are the following:

  • Voucher 1 – due April 15th for income earned between January 1st and March 31st of the tax year
  • Voucher 2 – due June 15th for income earned between April 1st and May 31st of the tax year
  • Voucher 3 – due September 15th for income earned between June 1st and August 31st of the tax year
  • Voucher 4 – due January 15th of the following year for income earned between September 1st and December 31st of the tax year

A final note – as shows above, payments are due on specific dates for income earned within certain time periods. For instance, if you sold a residence on May 1st and received a $200,000 taxable capital gain, taxes on the income would be due with Voucher 2 on June 15th. If you pay the associated taxes with a later voucher after June 15th, you may still be subject to interest and penalties, even if the full amount was covered by your later payment.

Questions? Call Gulla CPA to set up a consultation.

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