Depending on increases in the complexity of your income, you may owe the IRS and state taxes on a quarterly basis, as opposed to the annual tax bill you may be used to when you’re doing your usual filing.
What determines how “complex” your income is? Typically it’s “non-wage income”, which is income that doesn’t come from your paycheck from an employer and therefore does not have tax withholding automatically applied to it. Taxes related to his non-wage income could be due on a quarterly basis.
If you choose not to pay quarterly, you will incur underpayment penalties when you pay the full amount with the annual filing of your tax return (for some people, this is totally fine! We explain this in more detail below).
Quarterly tax payments can seem intimidating, particularly in the first year that this happens for you or your household. We recommend that you think of them not just as an extra bill/hassle from the IRS, but a great opportunity to start being strategic about your overall tax plan as part of your financial goals. As you level up in income complexity, there are more opportunities custom to your situation that you can take advantage of to lower your tax bill.
Who has to pay taxes quarterly?
The answer is: No one, technically. Just like you can theoretically choose not to pay the annual taxes you owe by 4/15, and pay penalties and interest the following year, you can also choose not to pay taxes quarterly when they’re owed and have the penalties apply when you file annually.
It’s not as bad as it sounds, and for some, skipping quarterly payments is a conscious strategy, not just because you didn’t know you owed them or didn’t understand the process.
For most folks, once they know that they’ve hit a point that quarterly tax payments start to apply, they want to know exactly how much they owe quarterly. This is because they’d rather pay the smaller amounts 4 times a year without the penalties instead of in one large lump sum at the end of the year, and also because this quarterly process helps with tax planning (basically, paying less in taxes overall).
What triggers quarterly tax payments? Rental income, investment gains, side businesses, and startup equity
Quarterly tax payments come into play when you hit a certain point of income complexity. Keep in mind this is not the same as how much income you make (ex: the statement “once I make over $200,000 a year, I’ll have to think about quarterly tax payments” is false!). You can have a relatively low or average income with high complexity, just like you can have high, very straightforward income from one paycheck.
Once you hit that point of complexity, the frequency of how you’re taxed fundamentally changes away from the annual tax bill that you’re used to when you do your annual filing, to a quarterly schedule of owing tax payments to the IRS and your state(s).
Quarterly tax payments start to apply to anyone with non-wage income that doesn’t have tax withholding applied to it automatically. This mean that any income outside of your W-2 from a full-time job, the most common of which are:
- Income from rental properties you own
- Investment gains in stock that you own, including cryptocurrency
- Income from a side business (consulting, freelancing, LLC)
- Exercising NSOs or vesting RSUs (technically this is wage income, but there is typically a shortfall between the automatic withholding from your paycheck and what you actually owe)
These scenarios aren’t mutually exclusive — you can be a tech employee that exercised NSOs and had income from a side business as well in the same year. All of these types of income (but particularly #4) tend to be very spiky, meaning some years you’ll have very large gains, and some years you may have less income or even 0 income in a certain category, which can make budgeting difficult because it results in a similarly spiky tax bill, one that is overall, much larger than you’re used to.
Does it make sense for you to plan for quarterly payments?
You have two options once you start owing quarterly tax payments:
- Understand that this happens and choose to skip the quarterly payments, acknowledging you’ll pay the underpayment penalties with the filing of your tax returns in April.
- Do quarterly tax projections and quarterly tax planning so you can know how much to pay on time and find opportunities to save money throughout the year.
An example of scenario 2 would be your accountant telling you:
“In 2021, you will owe $8,000 in Federal and $3,000 in State taxes each quarter. If you can sell securities to realize a loss and offset your gains this quarter, we could bring those amounts down by $2,000.”
Situations in which it makes more sense to pay quarterly tax payments on time:
- You have triggered a substantial, atypical spike in gains in non-wage income and it makes much more sense to manage this windfall with tax planning by meeting with your accountant more often for this tax year, even if your situation returns to normal next year.
- You live in a state with a particularly high underpayment penalty (for example, New York’s is 7.5%) and accumulating that throughout the year is expensive.
Situations in which it makes more sense to skip quarterly tax payments and just pay when you file annually:
- You live in a state with a particularly low underpayment penalty (for example, Missouri’s is 2.352%) and you can eat the cost without an issue.
- You are an active investor and strategically timing when certain cash can be freed up to be invested makes sense for you, and you are willing to eat the penalty rate (because your returns will be higher). You’ll still need an accountant’s help to figure out how much cash you have to do this with so that you’re budgeting properly for the year.
Also, keep in mind that your decision can be applied piecemeal — you can choose, for example, to pay the NY payment to avoid the high 7.5% underpayment penalty, but pass on the federal payment since you could more easily beat the 3% rate in the market with that cash.
Quarterly tax payments as an opportunity for lowering your overall bill
One of the main advantages of quarterly tax projections is that they avoid this very common scenario: It’s March of next year, and you’re doing just your typical annual filing. You have a particularly high tax bill due to a spike in non-wage income, and you ask your accountant “is there anything we can do to lower this tax bill?”.
Unfortunately, when it’s close to the tax deadline:
- The underpayment penalties are locked in — you didn’t pay quarterly so you are being penalized, as expected.
- You missed the window to strategically sell holdings. Any realized losses that could drive down taxable income had to be done by 12/31 of the previous year.
- Your 401(k) contributions had to be done by 12/31.
- Charitable contributions have to be paid or mailed in by 12/31.
- Any custom strategies for your scenario are much less likely to be possible.
What is the Safe Harbor method for quarterly tax payments?
There is a broad approach that is less specific to your situation but could help you take care of your quarterly payments in a straightforward way. Safe Harbor is particularly a great strategy for you if, for example, 2021 is a big year in gains and 2020 income was mostly just wages.
Your CPA can do one or two calculations for what your estimated quarterly tax payments could be for the whole year.
They can figure out the lower amount between these two:
- 110% of your prior year tax: This is the Safe Harbor method, and typically free of charge. Pretty straightforward because last year’s all said and done.
- 90% of your projected current year tax: This is slightly more complicated because it requires some projections, since current year tax will have to be an estimate, and typically costs a bit more.
And report either of these numbers to you, based on your preference. For example, “Based on the Safe Harbor method, your estimated quarterly tax payments for 2021 are: $10,000 for federal and $5,000 for state each quarter.”
Think of the Safe Harbor approach (#1) as a broad, safe approach that gets you some optimizations (avoid underpayment penalties) but isn’t the most strategic (you might be overpaying and get some money back). The second approach also gets you some broad optimizations but might not be totally accurate if your tax situation this year ends up being substantially different than expected.
How strict are the quarterly tax payment deadlines?
For Federal taxes in 2021:
|Payment Period||Due Date|
|January 1 – March 31||April 15|
|April 1 – May 31||June 15|
|June 1 – August 31||September 15|
|September 1 – December 31||January 15 of the following year|
State tax deadlines vary from state to state, but it’s typically most efficient to just pay them the same time you pay your federal tax so that you’re not having to manage two separate but slightly different sets of deadlines.
It’s important to note that the quarterly tax deadlines are considered softer deadlines compared to annual tax return/extension deadlines. We’ve seen clients pay up to two weeks after the quarterly deadline and have not been assessed with any penalties. This means you can take a bit of additional time to gather the necessary funds, if needed.
How do I know I owe quarterly tax payments? How do I submit the payments?
Here’s a typical process:
- This is generally good advice, but particularly for quarterly tax payments: Be sure to keep your accountant up to date on major changes to your tax picture! Be vocal and send them regular updates so that they can be aware if you’re expecting your current year to be substantially different than the previous year that they already filed for you.
- Based on your updates, your CPA may tell you that you are likely to owe quarterly tax payments this year and may recommend a few services that would be helpful, based on your goals (i.e. saving money overall, freeing up cash for investments, etc.).
- If you do not have a CPA or your CPA doesn’t have your most up-to-date information on file, you’ll likely find out that you owed quarterly tax payments on your annual tax return after the fact, where you’ll see that you may have incurred federal and state underpayment penalties throughout the year.
- Once a quarter, your CPA can assess your income for that quarter and also identify opportunities for you to move funds around, take certain actions, etc. to lower that tax bill.
- Quarterly, they report to you the amount that you owe, Federal and State, and can help you figure out how much of that amount to pay (if at all).
- You pay these amounts on time, with no penalty.
The mechanics of paying: Typically, your accountant can provide tax vouchers to mail with checks, but most of our clients at Harness Tax prefer to pay online via the IRS website here and via the NY state website (or similar) here. Once paid, you’ll have to send over confirmation of payment to your accountant for your records.
We hope you found this information helpful! Quarterly tax payments can be a bit confusing because there are so many factors that are custom to your particular situation and preferences, so we highly recommend speaking to a CPA that can provide plenty of context and help guide you through the best overall approach.
If you have any questions about this or are interested in becoming a client of Harness Tax, you can learn more about the firm here.