How do quarterly estimated tax payments work?
Now, it's important to note that what we're referring to here is your income tax payments. If you have payroll tax filings or sales tax, those are separate—that’s not what we’re covering. We’re talking about your federal income tax quarterly payments.
When someone is a W-2 worker, income tax is withheld from every paycheck by the company. The IRS doesn’t care about quarterly tax payments for people who are W-2 workers. It’s only when you have a business and you’re self-employed that the IRS expects you to figure out what you owe in taxes every quarter and send them a payment.
The reason one would want to do this is because the IRS has what they call an underpayment penalty. That means they’ll look at what you owed in taxes for the year compared to what you prepaid through estimated quarterly payments. If you’re under the amount that you owe, they can charge you a penalty. However, they look at the underpayment penalty based on what you paid in for the whole year—not necessarily the timing of when those payments happened. That timing will matter in a minute when I explain more.
Let’s talk about the technical aspect of how this works. At the end of every quarter, if you’re self-employed—meaning your income is from your own business and not just from W-2 wages—the IRS gives you the option to make payments. The due dates are April 15th, June 15th, September 15th, and January 15th. Occasionally those dates shift due to weekends or holidays, but for simplicity, let’s just go with the 15th.
That means, if I’m a self-employed person, the IRS wants me to estimate what I owe in taxes and make a payment by April 15th based on income from January 1st to March 31st. Then, for the second quarter—April 1st to June 30th—I’d make a payment by June 15th. The same goes for the other quarters, hence the four dates: April 15th, June 15th, September 15th, and January 15th.
Again, the underpayment penalty is what we’re trying to avoid. The IRS determines whether you owe this penalty based on what you prepaid in income tax between January 1st of the current year and January 15th of the following year. They compare that to your total tax owed. If you were short, you’ll likely be charged a penalty.
Now, I want to avoid unnecessary taxes whenever possible, but I also want to have enough cash to run my business and sustain my life. So, I want to explain all your options when it comes to quarterly estimated tax payments.
If you’re someone who isn’t great at saving money—meaning you run the risk of spending what you owe in taxes on other things—then I recommend, for simplicity, just making those estimated payments on the quarterly deadlines.
If, however, you are good at saving money and won’t be tempted to spend it, then I recommend a different method—and this is the method I use. I follow Profit First, which is a cash flow management system that, if you haven’t heard of, is a game-changer.
As part of my system, I have a separate bank account set aside specifically for income tax. Every time I sit down to manage my money—which for me is twice a month—I move a little bit of money into this tax account. Over the course of the year, that account grows.
When I get to December, I run a tax estimate and do some planning to figure out what I owe in taxes. By that point, 11 months have already passed, so I have real data and only need to estimate for one month. I use that information to calculate what I owe, and then I make one payment in December.
This approach also helps when estimating state taxes, since sometimes you can get a tax break for paying them before the year ends—but I won’t go too far into that. The focus here is on how estimated payments work.
So, I save money, estimate what I owe in taxes, and make a payment by December 15th. Now, if my December 15th payment ends up being short, I could still get hit with an underpayment penalty. But if my December payment is equal to or greater than the estimated vouchers provided to me—or in my case, the ones I’ve calculated—and I make that payment, then I avoid the penalty.
The situation where people tend to get in trouble is if they owe less than they owed last year and don’t come close to paying that amount. That’s usually when the underpayment penalty hits.
That being said, let’s say I have a great first three quarters but a disastrous fourth quarter. What happens then? Well, usually that means I’m not making a profit in Q4—I might even have a tax loss, meaning more expenses than income. If I’ve been making payments to the IRS based on those three great quarters, then Q4 hits and I’ve overpaid. But I don’t get that overpayment back until I file my tax return. That creates the risk of a cash shortfall if something bad happens in the business.
That’s why I prefer to hold on to all my tax money myself throughout the year and make just one payment in December. At that point, I can look at what actually happened in those 11 months and estimate just December—less chance of massively overpaying. It also gives me the flexibility to use year-end strategies. For example, maybe I’ve got $20,000 saved in my tax account and I see an opportunity for a $5,000 strategy that saves me several thousand in taxes. I can use part of that tax money to do it.
That was a lot of info, so here’s a quick summary:
If you want to keep it simple, just make the quarterly payments on April 15th, June 15th, September 15th, and January 15th.
If you’re like me and prefer to hold on to your money as long as possible while still avoiding underpayment penalties, then I recommend setting aside the money in a separate bank account throughout the year and making one payment in December.
We can help you with all of this. Depending on your service level, it may already be included—or it might be a small additional cost. But those are your two basic options, and now you know how quarterly estimated payments work.
