What exactly are estimated taxes?
First, you need to understand that the US Federal income tax system operates on a pay-as-you-go basis. Or as the IRS cleverly says, “pay as you go, so you don’t owe.”
If you’ve ever been someone else’s employee, you know that your employer takes some Federal taxes out of your paycheck every payday, sends them to the IRS, reports them to you on your W-2 at year-end, and you get credit for paying them when you fill out your annual tax return.
When you’re self-employed (you might call yourself a contractor, coach, consultant, author, speaker, educator, 1099 worker, freelancer, independent business owner, etc.), there isn’t an employer to do that for you.
Here’s what the IRS says:
“Taxes must be paid as you earn or receive income during the year, either through withholding or estimated tax payments. If the amount of income tax withheld from your salary or pension is not enough, or if you receive income such as interest, dividends, alimony, self-employment income, capital gains, prizes and awards, you may have to make estimated tax payments. If you are in business for yourself, you generally need to make estimated tax payments. Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and alternative minimum tax.”
Here’s what that means:
Estimated taxes aren’t really taxes at all, but a way to make payments during the year towards the amount of various Federal taxes you might owe when you file your Form 1040 for the year.
For a free cheat sheet on estimated taxes, click here.