How to Compute Estimated Taxes
The Internal Revenue Service requires you to pay estimated taxes on your income as you earn it during the year. Most people do not have to worry about making estimated tax payments because their employer automatically withholds taxes from their paychecks. However, if you are an independent contractor or self-employed, you must make the estimated payments on your own or the IRS will charge you late payment fees and interest. Use any one of several methods of withholding calculation offered by the IRS.
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Instructions
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Determine your adjusted gross income (AGI) and total tax liability from the prior year to determine how much you must put aside if you use the prior year's taxes to calculate your estimated taxes.
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Multiply your income tax liability by 1.1 to determine how much you must pay in tax withholding if you use the prior year's tax liability if your adjusted gross income exceeds $75,000. For example, if your tax bill was $10,000, you would have to pay $11,000 during the year to satisfy tax withholding. If your AGI is below $75,000, you must pay estimated taxes equal to your prior year's tax liability.
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Estimate your tax liability for the current year based on the income you expect to earn and the tax deductions and credits you expect to be able to claim.
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Multiply your estimated tax liability by 0.9 to calculate the minimum you need to pay in estimated taxes during the year if you use the expected income method.
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Choose the estimated tax computation method that allows you to pay the least and feel certain that you will have enough withheld. If you have a fluctuating income, you may be better off using the prior year's tax liability method because it gives you a fixed number to pay in estimated taxes. Even if your income skyrockets, you will still have met your requirement. However, if your income skyrockets and you were making estimated tax payments based on a much lower expected income, you may have to pay penalties and interest.
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Tips & Warnings
If you pay too much in estimated taxes during the year, you will get a tax refund when you file your tax return at the end of the year.
