Subject to the potential imposition of penalties, any taxpayer who expects to owe tax of $1,000 or more is required to make estimated tax payments.¹ In other words, a taxpayer should project the current year’s taxable income, tax and credits based on expected income, deductions, etc. Based on “a pay as you go” method, estimated tax payments are payable periodically throughout the year. For this purpose, tax liability includes regular income tax, alternative minimum tax and self-employment tax (Social Security and Medicare tax).²

For self-employed taxpayers, the requirement to make estimated payments is more problematic than for employees. Unlike employees, no part of a self-employed individual’s compensation is withheld by the payor and paid over to the IRS for taxes. Moreover, in addition to regular income tax, these taxpayers are required to pay the full 15.3 percent of the Social Security and Medicare tax. For this reason, a self-employed individual with even a modest amount of income who may owe little or no income tax, may, nonetheless have a significant Social Security and Medicare tax liability.

However, even employed individuals who are subject to withholding should consider making estimated payments under the following circumstances:

• The amount being withheld by the employer is insufficient.
• The taxpayer has a significant amount of other income such as dividends, interest, rent, etc. that is not subject to withholding.

On the other hand, an individual need not make estimated payments if all three of the following conditions are met:

• The individual had no tax liability for the prior tax year.
• The individual was a U.S. citizen for the entire tax year.
• The prior tax year was a 12 month period.³

Although estimated payments can be made at any time during the tax year, there is a “required annual payment” that is payable in “required installments” with specific due dates. For that purpose, the tax year is divided into four quarters with the following due dates:

The “required annual payment” is a) 90 percent of the taxpayer’s expected tax liability for the tax year or b) 100 percent of the tax owing for the prior tax year (assuming the prior tax year spanned 12 months).⁵ However, if the taxpayer’s adjusted gross income exceeded $150,000 ($75,000 for filing married filing separately), the percentage in b), above, is increased to 110 percent.⁶

Planning Point: For the 2018 tax year only, the IRS lowered the threshold to 80 percent to account for the significant changes made to the tax code late in 2017. This relief applies both to taxpayers who paid through employer withholding and those who paid quarterly estimated payments (or any combination). If the taxpayer qualifies for this relief but has already filed a return for 2018, the taxpayer can request a refund using Form 843, which must be filed in paper format.⁷

In August, 2019, the IRS announced that it will automatically waive the otherwise applicable penalties for failure to pay sufficient estimated income tax for certain taxpayers who filed their 2018 returns, but failed to claim the available waiver. This means that the IRS will waive penalties for taxpayers who paid at least 80 percent of their estimated tax liability by January 16, 2019, regardless of whether those payments were made in four equal installments. Eligible taxpayers who failed to claim the waiver and paid the penalty will receive a notice and a refund check approximately three weeks later. Because the relief is automatic, there is no need to contact the IRS to obtain a refund.

If the taxpayer fails to make timely estimated installment payments, the taxpayer is subject to penalties. Although the taxpayer can compute the penalty on Form 2210, the IRS will compute the penalty if the taxpayer does not complete the form.

An individual who has annual net earnings from self-employment of $400 or more is subject to self-employment tax.¹ Generally, sole proprietors, single member LLCs treated as a disregarded entity and general partners are considered to be self-employed. Self-employment tax is reported on Schedule SE attached to Form 1040. However, a self-employed taxpayer is entitled to an above-the-line deduction equal to one-half of the self-employment tax paid.²

In essence, self-employment tax is the combination of Social Security tax and Medicare tax. The Social Security tax rate is 12.4 percent and the Medicare tax rate is 2.9 percent.³ For 2024, Social Security taxes apply only to the first $168,600 of self-employment income ($160,200 in 2023). If the taxpayer has both wages and self-employment income, the amount of self-employment income subject to the Social Security tax is the difference between the cap amount and the amount of the taxpayer’s wages.

Example: In 2024, Asher has wages of $100,000. In addition, Asher has self-employment income of $90,000. Since the Social Security wage base is $168,600, only $21,200 of Asher’s $90,000 of self-employment is subject to Social Security tax.

On the other hand, in regard to Medicare tax, there is no cap on the amount of self-employment income that is subject to the tax. Also, for self-employed individuals with income that exceeds certain threshold amounts, an additional Medicare tax of 0.9 percent may be added to the base 2.9 percent Medicare rate, for a total tax of 3.8 percent. The additional tax applies for self-employed individuals with income in excess of $250,000 for joint filers, $125,000 for married taxpayers filing separately and $200,000 for all other taxpayers.⁴