Definitely one of the top five questions I get asked is how much people should pay for quarterly taxes and when. But many people confuse a lot of different ideas, so I wanted to take a minute to straighten them all out.
There are a couple different terms/ideas around taxes and paying taxes: Quarterlies, Estimated Taxes, and Withholdings.
“Quarterlies” is the colloquial term for the quarterly payroll tax returns (Form 940, plus various state forms). This is only if you are paying people on a W-2. It used to be fairly common to prepare your own payroll taxes and have to file a 940 each quarter to pay your employer taxes. But with the rapid increase in Professional Employment Organizations (PEO) and payroll services like Gusto – most of this can (and absolutely should be) automated away.
Estimated tax payments, which are also due quarterly on April 15th, June 15th, Sept 15th and January 15th (NOT the same dates that payroll forms are due) is a voluntary payment you make to the Fed to pay your income taxes (as distinct from your payroll taxes). If you are a freelance worker and have no withholdings (below) then you will earn income throughout the year and not pay any tax, leaving one giant tax bill at year end.
While estimated taxes are not required, the IRS does charge a penalty if you don’t pay them. It can be a bit of a convoluted calculation but generally speaking at tax time if you have balance due, but paid in at least as much as you owed in tax the previous year, you will not owe a penalty. This also assumes that you paid your estimates in four roughly equal installments throughout the year. If you owed around $10,000 in tax last year and expect to owe the same this year and pay nothing, you’ll add around $250 to your tax bill (about 2.5%) come tax time.
Withholdings are what your employer takes out of your paycheck and sends in your behalf. It is, effectively, the same thing as estimated payment just in a different form. Your employer calculates how much to withhold based on the W-4 you provide them. On that form you provide a number of “exemptions”. The calculation for withholdings annualised that one paycheck, subtracts the exemptions you told them to, and figures the tax, then divides by it the number of pay periods. This is why W-2 people can get refunds or still owe money – you might have more (or less) deductions that you provide your employer. Or any number of other factors (credits, spouse income, business/investment income, etc). It is also why your tax rate jumps up when you get a bonus – the formula assumes you get that much money every paycheck and, if that was true, you would owe a higher tax rate.
Quarterlies – Payroll taxes for employers your payroll software will do this. If not, you’re doing it wrong.
Estimated – Tax payment of choice for freelancers. Totally your choice how much to pay and when.
Withholdings – What your employer takes from your check and sends in on your behalf. Should be on auto pilot.