Tax payments should be paid as you earn or receive income throughout the year, either by withholding taxes on your paychecks or in the form of estimated tax payments (or a combination). If the amount of income tax withheld, or if you receive income where no taxes are held (such as interest, dividends, self-employment income, capital gains) you may have to make estimated tax payments. If you are self-employed, you generally need to make estimated tax payments. Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax.
If you don’t pay enough tax through withholding and/or estimated tax payments, you may be penalized. You also may be penalized if you are paying estimated taxes after the deadline, which can accumulate over the course of the year.
You don’t have to pay estimated taxes in the current year if you meet all three of the following conditions:
- You had no tax liability for the prior year
- You were a U.S. citizen or resident for the whole year
- Your prior tax year covered a 12-month period
You had no tax liability for the prior year if your total tax was zero or you didn’t have to file an income tax return.
The whole purpose of paying estimated taxes is to avoid the underpayment penalty. It is true that if you send in too much money when you pay estimated taxes, you’ll just get the over-payment refunded back to you at year-end when you do your tax return. But then again, you don’t want to send in too much money, otherwise, you might have a cash-flow or cash-crunch issue. So it may be a difficult balancing act when you pay estimated taxes because you don’t want to send in too much or too little.