Quarterly Estimated Taxes: When Side Income Has to Be Paid Early

The American tax system is pay-as-you-go. Not pay-in-April, which is what almost everybody assumes because that is how it feels when you have a salary.

Employees satisfy the rule without ever thinking about it, because an employer withholds tax from every payslip and sends it in on their behalf. Nobody with side income is doing that for you. If enough of your income arrives untaxed, you are expected to send money in four times a year, and there is a penalty for not doing it even if you pay every cent you owe by the deadline.

That last part is the one that catches people. Paying in full and on time is not enough. The system also cares when you paid.

Whether this applies to you

The test is simple: if you expect to owe $1,000 or more when you file, after subtracting any withholding and refundable credits, you are expected to pay estimated tax through the year.

A thousand dollars of tax is not very much income. On the effective rates that side work usually attracts, profit somewhere in the region of $3,500 to $4,000 gets you there. A moderately successful year of freelancing clears it comfortably.

Two situations let you off. If you had no tax liability at all last year, and you were a US citizen or resident for the whole year, no estimated payments are required this year regardless of what you earn. And if your withholding from a job covers enough of the total, the side income can ride along underneath it without separate payments.

When each payment is due

The deadlines are 15 April, 15 June, 15 September, and 15 January of the following year. If a date falls on a weekend or a holiday it moves to the next working day.

They are not evenly spaced, and the periods they cover are not three months each.

The second payment is the one people miss. It arrives only two months after the first, at a point in the year when nothing else is prompting you to think about tax, and it covers the shortest period of the four.

How much to send, and the two safe harbours

You do not have to predict your year accurately. There are two ways to be safe from the penalty, and you only need to satisfy one of them.

The current-year test. Pay at least 90% of what you end up owing for this year. Accurate if your income is steady, and a guess if it is not.

The prior-year test. Pay at least 100% of your total tax from last year. If your adjusted gross income last year was over $150,000, the figure is 110% instead.

The second one is the useful one, and it is underused. It relies on a number you already know, printed on a return you have already filed, and it does not care what happens to your income this year. Take last year's total tax, divide by four, pay that four times, and the penalty cannot touch you even if you triple your income and end up owing far more.

You will still owe the difference at filing. The point of a safe harbour is not to avoid the tax. It is to avoid the penalty for having paid it late.

This makes a genuinely good year much less stressful. Your obligation through the year is fixed by last year's return, so the extra tax on the extra income can simply be set aside and paid in April.

How to catch up after missed payments

This is the most useful thing on this page, and hardly anybody knows it.

The penalty is worked out quarter by quarter. Miss the April and June payments and catch up with a large payment in September, and you still owe a penalty for the two quarters you were short, because estimated payments are credited when they are actually made.

Withholding is different. Tax withheld from wages is treated as having been paid evenly across the whole year, no matter when in the year it was actually withheld. That rule is what makes the repair possible.

So if you reach November having paid nothing and you also have a job, you can file a new Form W-4 and have a large amount withheld from your remaining paychecks. That withholding is deemed to have been spread across all four quarters, and it can cure the earlier shortfalls retroactively. An estimated payment made on the same day cannot do that.

The same trick works with a retirement account distribution, where you can elect a large withholding percentage, though that has its own consequences and is a bigger decision.

If you have a spouse with a salary, their withholding works for a jointly filed return in exactly the same way. It is often the cleanest fix available.

What the penalty costs

It is not a fine. It works like interest, charged on how much you were short and for how long, at a rate the IRS sets each quarter and which tracks short-term market rates.

Which means two things. It is usually much smaller than people fear, often tens of dollars rather than hundreds on a modest shortfall. And it is not a catastrophe to be avoided at any cost: if the alternative is a cash flow problem in June, paying the penalty is sometimes the sensible commercial decision.

It is calculated on Form 2210, and in most cases the IRS will work it out and bill you rather than making you do it.

When your income is lumpy

The standard method assumes your income arrives evenly. A lot of side income does not. A single large project in November, one seasonal quarter, a business that only earns in summer.

Paying a quarter of the year's tax in April when you have earned nothing yet is a real cash flow problem, and the system has an answer: the annualised income instalment method. It works out your required payment for each period based on what you had actually earned by then, so a quarter with no income requires no payment.

It is more work. You complete Schedule AI of Form 2210 and you need income and deduction figures cut off at each period end, which means keeping books through the year rather than reconstructing them. For genuinely seasonal income it is worth the effort, and for anybody else the prior-year safe harbour is simpler and does the same job.

How to pay

The vouchers in Form 1040-ES exist and almost nobody needs them. IRS Direct Pay takes a payment from a bank account with no fee and no registration, and gives you a confirmation to keep. EFTPS is the enrolment-based system, better if you want a schedule of payments set up in advance. Cards work and carry a processing fee.

Two things worth doing. Keep the confirmation for every payment, because reconciling a missing one against an IRS notice a year later is miserable. And check whether your state wants estimated payments too, because most with an income tax do, usually on the same dates and with their own rules.

A three-step system for the year

The system that fails is trying to remember four dates. The system that works has three parts.

Take last year's total tax and divide by four. That is your payment, fixed, requiring no forecasting. Use 110% of it if your income was over $150,000.

Set aside tax from each payment as it arrives, into a separate account, at a percentage decided once. That is where the quarterly payments come from, so they never compete with anything else.

Put the four dates in a calendar with a reminder a week early. Particularly 15 June, which is the one that gets missed.

Done that way it takes about ten minutes a quarter and removes the possibility of an unpleasant April.

Where this fits with everything else

For what you actually owe on side income in the first place, including the self-employment tax most people leave out of their estimate, see side hustle taxes, which has a calculator for the figure you would be dividing by four here.

If you are still choosing what the side income should be, our guide to 25 ways to earn money from home and online covers the options.

And if the profits are large enough that the payments are becoming uncomfortable, a retirement account can reduce the taxable amount substantially. That is covered in Solo 401(k) or SEP IRA for side income.

Sources

The thresholds, due dates and safe harbour percentages are set out in the IRS guidance on estimated taxes. The penalty calculation, the annualised income method and the treatment of withholding are covered in Form 2210 and its instructions.

Frequently asked questions

Do I have to pay quarterly taxes on side income?

If you expect to owe $1,000 or more when you file, after withholding and credits, then yes. On typical effective rates that is roughly $3,500 to $4,000 of profit. Below that, or if withholding from a job already covers your total, you can pay at filing.

What happens if I miss a payment?

You owe an interest-style penalty on the shortfall for the period you were behind, calculated per quarter. It is usually modest rather than punitive, and paying the missed amount as soon as you can stops it growing.

How much should I pay each quarter?

The safest simple answer is a quarter of last year's total tax, or 110% of it divided by four if your adjusted gross income was over $150,000. Meeting that safe harbour protects you from the penalty whatever this year turns out to be.

Can I catch up later in the year?

With estimated payments, only partly, because they count when they are made. With withholding, yes: tax withheld from wages counts as paid evenly across the year regardless of when it was withheld, so increasing withholding late in the year can fix earlier quarters.

What if my income is seasonal?

Use the annualised income instalment method on Schedule AI of Form 2210, which sets each period's requirement from what you had actually earned by that point. It is more work and it stops you having to pay tax in April on income you will not receive until October.

Do I need to pay state estimated taxes too?

Usually, if your state has an income tax. Most follow the same four dates with their own thresholds and safe harbours, and the state penalty is separate from the federal one.

What if I overpay?

You get it back as a refund, or you can apply it to next year's first instalment, which is often the tidier option. There is no penalty for overpaying, only the cost of having lent the money for a while.