For those Americans who pay quarterly taxes - or those who don't but who think they should - understanding the rules governing estimated taxes is vital.
Paying taxes is never a fun prospect -- and paying estimated taxes, depending on your level of income, generally adds to the stress and can reach an unsettling degree of complexity.
For those Americans who pay quarterly taxes -- or those who don't but who think they should -- understanding the rules governing estimated taxes is vital, experts say.
Thomas Jensen, managing partner of Portland, Oregon-based Vaerdi Financial, and Sandy Zinman, founder of Zinman Accounting in White Plains, New York, dispel some of the myths surrounding quarterly tax payments and IRS Form 1099-MISC.
A misconception is that if you miss a payment by a couple of days, then you should just wait until your next payment is due. This is incorrect.
- Sandy Zinman, founder of Zinman Accounting, White Plains, New York
Do you owe estimated taxes?
The most important detail to understand, Jensen says, is how much and what type of income places you in the position of paying estimated taxes. You generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return. Estimated tax payments are made on a quarterly schedule established by the IRS.
It is the self-employed who normally must pay quarterly estimated taxes, although individuals who receive large, untaxed windfalls -- from investment gains from stocks for example -- may also be required to pay estimated taxes.
Many people misunderstand Form 1099-MISC income, Jensen says. He believes this is the No.1 error regarding paying quarterly estimated taxes.
“It’s less a myth than a misconception,” Jensen said. “People need to understand the difference of being a full-time employee and being a contract employee. People can work under a contract, but they’re getting a check on the first and the 15th of the month -- so it feels very much like a salary. But it’s not: They’re self-employed.”
One of the more serious misconceptions taxpayers may have is that they can just pay their estimated taxes in one lump sum at the end of the year.
This is a mistake typically made by someone new to paying estimated taxes, according to Zinman, a certified public accountant who chairs the tax committee of the National Conference of CPA Practitioners. It's incorrect to think the IRS is OK with an end-of-year payment, he said. If you owe more than $1,000, the IRS wants its owed taxes paid during the year. Any missed quarterly payment will result in penalties and interest.
Additionally, waiting until the end of the year may lead to financial mismanagement by people who fail to reserve enough funds to satisfy their tax debt, which is a problem that can follow a taxpayer into the the next year and beyond.
For a person who must pay taxes quarterly, following the schedule is enormously important, Zinman stressed. Missing quarterly deadlines, even by one day, will mean accruing penalties and interest.
“A misconception is that if you miss a payment by a couple of days then you should just wait until your next payment is due," Zinman said. "This is incorrect.” He advises sending the payment as soon as possible and appealing any penalty.
“The IRS can be pretty forgiving about penalties,” said Zinman. “They are a lot more interested in collecting the taxes than penalties.”
What is a 1099?
Many people misunderstand what a Form 1099-MISC denotes and who receives it.
A person who is considered an employee of a company -- whether salaried or paid by the hour -- will receive a Form W-2, which shows how much money has been withheld throughout the year for federal, state, Social Security and Medicare taxes. Such a person will be responsible for paying half of the payroll taxes due based on his taxable income. His employer withholds and pays the other half.
For the income reported on a Form 1099-MISC, however, no tax has been withheld by the party that paid the self-employed individual for work performed. The self-employed person is responsible for paying the full amount of payroll taxes on the amount listed on the Form 1099.
“The 1099 form by itself is nothing,” said Jensen. “A 1099 means you’re liable for self-employment tax.”
Some people mistakenly believe that if they receive a Form 1099, it does not necessarily mean the IRS received a copy, Zinman said.
That scenario, however, is highly unlikely, he said. “If you get it, the IRS got it,” he said.
Similarly, people erroneously believe that if they did not receive a Form 1099, they don't have to report the tax. The IRS, Zinman says, does not care whether you received your Form 1099. If you received untaxed income, you must report it. In fact, beginning in 2012 (for the 2011 tax year) businesses and corporations must respond, via a line-item question on their tax forms, whether they paid miscellaneous income during the year.
The Internal Revenue Service has established four due dates for paying estimated taxes -- unless you can pay estimated taxes for the year upfront. Typically, the due date is the 15th for each of the months in which payments must be made. If the 15th falls on a weekend or a federal holiday, however, the due date is moved to the following business day.
The schedule works out like this:
- For income received Jan. 1 through March 31, estimated tax is due April 15.
- For income received April 1 through May 31, estimated tax is due June 15.
- For income received June 1 through Aug. 31, estimated tax is due Sept. 15.
- And for income received Sept. 1 through Dec. 31, estimated tax is due Jan. 15.
A payment not postmarked on or before the due date will be considered late and you will be penalized.
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