I am on a 1099 for the first time this year instead of a W-2, and have just learned of this thing they call “Estimated Taxes”. I understand the concept that I must pay an estimated tax 4 times a year, however, in going thru the IRS worksheet there is one thing that I’m not sure about. If I’m reading this correctly, I compare my estimated tax for all of 2007 to my tax from last year, and use the lower of the two to calculate my estimated tax for the first quarter of this year.
Is this correct? If so, what is the logic behind it?
Also, while I’m here, is the same procedure used in the District of Columbia?
It’s a matter of avoiding penalties while paying as little estimated tax as you can get away with. If you make less than $150K, you can avoid paying penalties if you either:
1 - prepaid 100% of last years taxes, OR
2 - prepaid 90% of the current years taxes.
If you make more than $150K, that’s 110% of last years.
(This is assuming you prepay in equal quarterly payments)
Thus, if you expect to make a lot more money in 2007, you can simply prepay the same amount of tax you paid this year (or 110% if you are making better than $150K), and pay the rest at tax time without penalty. If you expect to make less, you’re better off trying to estimate what you will actually owe.
To add, here is my exact situation: my tax liability for 2006 will only be around $5000, while this year is should probably me 4x that. Do I have to pay estimated taxes this year?
On the assumption that you’re self-employed, find yourself a local accountant or tax preparer - they’ll know all the little quirks that can otherwise bite you hard next year, or whenever the IRS decides to take a look at your filings.
They’ll also be familiar with all sorts of deductions you might not be aware of.
If you are not going to have taxes withheld automatically in 2007, yes. And it sounds like you will want to pay either $5000 or $5500 in 4 quarterly installments, realizing that you are going to wind up with a large amount of taxes owed (but hopefully no penalties) in April of 2008. If you want, you can make larger estimated payments, and not have as large a bill in April 2008. The old adage about “giving the government an interest free loan” applies in that case.
If you didn’t have any taxes withheld THIS year, you were supposed to have been paying estimated taxes for 2006, and may incur penalties.
All this offered with a caveat that I am not a tax accountant, and don’t know your specific situation, of course.