Every American citizen who is earning a certain amount has to pay taxes. Those who are employed, often have taxes deducted automatically from their salary. However, those who are self-employed, or have additional means of generating an income need to calculate the correct amount due, and take the onus of responsibility for making timely payments. Since failure to make the payment, or paying less than the chargeable amount can have unfavorable consequences, we have put together a guide for people living in California: estimated tax payments, calculation method and penalties for not fulfilling the responsibility, all are discussed in this article.
The Overlap between estimated Tax and withholding Tax
The tax which is directly deducted from an individual’s salary is referred to as withholding tax. Employees who are subject to income tax deduction are required to submit W-4 and DE 4 forms to their employers, stating their tax withholding rate for federal and California-specific payments respectively.
Many individuals who have undergone tax deductions at the hands of their employers might also be liable to pay an additional amount to the government in the form of estimated tax. However, not being aware of this fact may result in the imposition of penalties on the individual. Therefore, the difference between withholding and estimated taxes must be understood, so as to remove any misconception and confusion regarding the overlap of these payments.
Basically, estimated taxes are applicable on the total amount an individual earns during the period. Most people assume that these taxes are specific to freelancers or self-employed individuals since salaried personnel already have their share deducted from their paychecks. However, the truth is that many salaried individuals earn extra income in the form of dividends, rent, or return on different types of investments. These earnings cannot go untaxed.
As the name suggests, the amount payable as an estimated tax needs to be gauged by the individual themselves and they are solely responsible for ensuring timely payment. One advantage that salaried personnel who make extra side income have in this regard is that they may request their employer to deduct taxes from their paycheck, using a higher withholding rate than applicable, so as to make up for the estimated tax.
Having clarified why sometimes an individual may be charged with taxes under dual categories, we have further listed down the criteria which may help you assess whether you are liable to pay federal and California specific estimated tax or not.
Are you liable to pay estimated tax?
In order to answer this question, you need to consider whether you fall in any of the following categories. If you do, then you are responsible for making the aforementioned payment to the federal government.
- You are a citizen of the United States, a permanent resident but not a national of the country, or a nonresident alien.
- You are a resident of Territories of the United States; namely American Samoa, Northern Mariana Islands, the U.S. Virgin Islands, Puerto Rico or Guam.
- After subtracting your federal income withholding tax from the total tax amount due, you are left with $1000 or more.
- If the sum of your federal income tax withholding and any other timely payments of estimated taxes add up to an amount which is less than the lower value amongst these two:
- The total tax you paid last year
- 90% of the amount you are liable to pay in the current year
Since requirements may vary for each state, it is no surprise that the threshold for California is slightly different from the federal criteria mentioned above. Since we are particularly focusing on information that may be useful for residents of California, estimated tax payments to this state will be due if:
- You expect to owe $500 or more in taxes
- The sum of your state withholding tax and credits is less than the lower value amongst these two:
- The total tax you paid last year inclusive of the Alternative Minimum Tax (AMT)
- 90% of the amount you are liable to pay in the current year as taxes
Estimated taxes have to be paid every quarter. The due dates for each year are specified in advance. The only challenge is calculating the correct amount and ensuring that one does not pay an amount that is less than what is applicable based on their reported income.
How to calculate the correct amount for estimated tax?
The best method to determine an amount for both federal and California-specific tax payments is to use the previous year’s tax record as a guideline.
Federal estimated Tax Payments
One of the easiest ways to estimate a realistic value for your tax liability is to set aside an amount that is exactly the same as taxes incurred last year. However, for individuals whose adjusted gross income for the previous year exceeded $150,000, payment should be equivalent to 110% of the taxes charged last year. The same goes for the taxpayers who earned an amount of $75,000 or more the previous year and were married, but filed separate returns.
These are the generally accepted guidelines for estimating the value of one’s tax payments. Therefore, even if the amount you owe the federal government is more than what you pay on the basis of the above-mentioned criteria, you will not be charged with a penalty.
However, if you have a valid reason to believe that your annual income will be less than what it was a year before, you may pay an amount that is equal to 90% of the taxes paid last year. The drawback of this approach is that if the amount you actually owe exceeds the payment you made, you will be charged with a penalty. Also, any extra payments you make are refunded anyways so you don’t have anything to lose by keeping your estimate on the higher side.
The form used to calculate federal estimated tax for individuals is known as the IRS Form 1040 ES, whereas that used to derive a figure for corporations is the IRS Form 1120 W.
California estimated Tax Payments
According to state-specific guidelines, those whose adjusted gross income for the previous year exceeded $150,000, must make tax payments equal to 90% of the amount paid last year or 110% of that paid the year before the preceding one. The same goes for taxpayers who earned an amount of $75,000 or more the previous year and were married but filed separate returns.
In California, estimated tax is paid in installments. These payments should add up either to the exact amount paid the previous year or to 90% of the total amount due in the current year.
The form used to calculate estimated tax that needs to be paid to California authorities is referred to as FTB Form 540-ES.
How to determine the value for Periodic Payments?
California state authorities as well as the federal government demand that quarterly payments be made for estimated taxes. Therefore, 4 due dates are specified during a year; one for each installment. Even though the deadlines for federal and state payments are the same, there is a difference in the percentages that have to be paid to California Franchise Tax Board (FTB) and the Internal Revenue Service (IRS) respectively.
Below are the due dates for quarterly payments:
|September-December||17 January, i.e., first month of the following year.|
Federal Quarterly Payments
If your income is fairly stable all year round, then you may use a Regular Installment Method. This method suggests simply dividing the total estimated tax for the year by 4 to derive a value for each quarter.
However, if the amount you earn in a year significantly varies during each period, then we recommend using the Annualized Income Installment Method. In order to make calculations for the amount due each quarter, you will need to make use of the IRS worksheets 2.9.
In case you didn’t know, federal estimated taxes can be paid online via the Electronic Federal Tax Payment System (EFTPS). Also, you may avoid taking the burden all at once. The system allows you to make quarterly payments in small chunks every week or month, given that you pay the complete amount by the deadline.
California-specific Quarterly Payments
In order to deduce the figure you need to pay to California authorities in the form of estimated tax, certain percentages have been stated. Those are as follows:
California estimated tax payments can also be made online via the FTB Web Payment portal.
Penalties may be imposed if you pay less than the actual amount that was applicable to you as estimated tax.
IRS Form 2210 can be used to figure out the amount you owe as a penalty to the federal government. However, this calculation is quite complicated because rates change every year so it’s better to wait for the IRS to communicate the penalty to you. If you do so, you will be aware of the exact amount and still have a buffer. This means that if you make the full payment by a certain time specified on the bill, you won’t have to pay the penalty.
When talking about short payments made to California state authorities, underpayment penalties may be calculated using the FTB Form 5805. The advice we would give here is similar to our suggestion for federal penalties, i.e., let the FTB determine your penalty amount and make timely payments to avoid a surcharge.
Penalties may be waived under certain circumstances. These include but are not limited to:
- Cases where the unpaid amount is less than $1000 for federal estimated tax and $500 for California state estimated tax.
- Situations where the individual has no liability with respect to income tax for preceding year.
- When taxpayers meet the exemption criteria set for fishermen and farmers by the FTB and IRS.
Furthermore, waiver may be requested via Form 2210 for special circumstances, such as a change in filing status, late income generation, or being affected by a casualty. In order to confirm whether you are eligible for a waiver, check the IRS and FTB official websites for a complete list of individuals who may be eligible for exemptions.
If you do not fall under exceptional cases, it is important that you pay your taxes fully and on time. This is not just your responsibility towards the state and the country, but will also prevent you from having additional penalties imposed.