By Marc C. Shaffer
As a “finance guy” who loves numbers and making them work for a greater good, even I don’t love tax season. As I send my check off to the IRS, I’m thankful that our business continues to grow, but bidding farewell to the payment is my reminder to rework my financial plan for the year ahead. The updated estimated tax payments, which seem to creep up every year, become the new baseline for budgeting and cash flow planning.
If you’ve ever received income that didn’t have taxes automatically withheld, like freelance work, self-employment income, interest, dividends, or even a side hustle, you may have heard of estimated taxes. But what exactly are they, and why do they matter?
Let’s break it down.
What Are Estimated Taxes?
Estimated taxes are periodic payments you make to the IRS throughout the year on income that isn’t subject to automatic withholding. This can include:
- Self-employment or freelance income
- Rental income
- Dividends and interest
- Capital gains
- Retirement withdrawals (in some cases)
- Side jobs or consulting gigs
Instead of paying your tax bill in one lump sum at the end of the year, the IRS wants you to pay as you go. These payments are typically due on what the IRS refers to as a quarterly schedule, but it’s important to note that these dates do not align exactly with calendar quarters.
- April 15
- June 15
- September 15
- January 15 (of the following year)
This differs from the schedule businesses often follow for quarterly payroll or sales tax filings. For individuals making estimated tax payments, this schedule is a little quirky and can catch people off guard if they expect payments to be due at the end of March, June, September, and December.
Paying estimated taxes helps you avoid penalties and keeps you in good standing with the IRS.
Why Should You Care?
If you end up owing more than $1,000 when you file your tax return and haven’t paid at least 90% of your total tax liability (or 100% of last year’s, depending on your income), you could face an underpayment penalty.
Estimated taxes are a way to stay on top of your tax obligations and avoid surprises come tax time. They’re also a good reminder that income isn’t always as simple as a paycheck with automatic deductions.
A Quick Example
Imagine this: Lisa is a full-time marketing consultant who also sells photography prints online. She didn’t realize that the income from her print sales – though exciting – pushed her into a higher tax bracket. When tax season came around, she owed over $6,000 and had to dip into her emergency fund to pay the bill (plus penalties). After that, she got on a schedule to pay estimated taxes every quarter, and now she stays ahead of the game.
When and Why You Might Need to Adjust
Life changes. Your income might not stay the same from one quarter to the next, so your estimated payments shouldn’t either.
Here are a few reasons you might want to adjust your payments mid-year:
- You get a raise or start earning more through a side hustle
- You sell investments and realize a large gain
- You take a break from work or retire early
- You switch jobs or lose a source of income
- You make a large withdrawal from a retirement account
In all of these cases, your total tax picture changes, and your estimated payments should reflect that.
Real World Example
One of our clients left his corporate job mid-year to launch his own consulting firm. His income skyrocketed in the second half of the year, but his tax withholding from the first half didn’t cover this increase. Because we stayed in touch throughout the year, we were able to recalculate his estimated taxes after his business took off. He made two adjusted payments before year-end and avoided thousands in penalties and interest.
*Searcy Financial Services does not offer tax or accounting services, but your tax situation is taken into account to show how it will impact your overall financial plan. If you are a client in need of an introduction to an accounting or tax professional, we would be happy to help.
How Much Do You Need to Pay? Understanding the Safe Harbor Rule
One of the most common questions we hear is: “How much should I actually be paying each quarter?”
That’s where the IRS safe harbor rule comes in. It gives you a way to avoid underpayment penalties even if your income changes or you don’t calculate your estimated taxes perfectly.
Safe Harbor Thresholds:
To avoid penalties, pay whichever of the following is lower:
100% of your prior year’s total tax liability, or
110% of your prior year’s tax liability if your adjusted gross income (AGI) was over $150,000 (or $75,000 if married filing separately).
OR
90% of your current year’s expected tax liability.
Another Real-World Example
Another client had a long history of earning more than $150,000 annually, which meant he typically followed the safe harbor rule by paying estimated taxes equal to 110% of the prior year’s liability. However, his business unexpectedly lost a large contract mid-year, and he anticipated a 25% reduction in income, largely due to lower K-1 earnings from his business.
Rather than continuing to make quarterly estimated payments based on the higher prior-year income, we worked with him and his accountant to review updated income projections and tax expectations. After evaluating the numbers, we determined that the final quarterly payment wasn’t necessary. What he had already paid in earlier estimated payments, along with tax withheld from payroll, was enough to satisfy the 90% requirement of his current year’s expected tax liability.
By revisiting his plan before year-end, he was able to retain his final quarterly payment and improve his cash flow without risking an IRS penalty. This impacted his short-term liquidity. By walking through the numbers, he realized that the drop in income would primarily affect the highest tax brackets, meaning the impact on his overall tax liability would likely be less severe than expected.
If your total tax liability last year was $20,000:
- If your AGI was under $150,000, you would pay at least $20,000 this year in estimated payments (or through withholding).
- If your AGI was over $150,000, your safe harbor amount becomes $22,000 (110%).
- If you expect your income to drop, you could pay 90% of your current year’s projected liability, but this carries more risk if you’re off in your estimate.
Retired Doesn’t Mean Tax-Free: Why Estimated Taxes May Still Be Due
Many retirees are surprised to learn they still owe taxes in retirement. That’s because retirement income isn’t always taxed automatically.
Sources That Can Trigger Estimated Tax Needs:
- IRA and 401(k) distributions — often fully taxable and may not have enough withholding.
- Social Security benefits — up to 85% may be taxable, especially when combined with other income.
- Pension income — may not withhold enough by default.
A Common Scenario
Consider Mary, a 72-year-old retiree drawing from both a traditional IRA and Social Security. Her financial institution was withholding only 10% from her IRA distributions, and she hadn’t set up any withholding from her Social Security. When tax season came, she owed several thousand dollars and faced penalties.
By adjusting her IRA withholding to 20% and filing Form W-4V to withhold 7% from Social Security, she’s on track and no longer needs to make quarterly estimated payments.
Pro Tip – You can often avoid estimated payments entirely by increasing tax withholding from IRA, pension, or Social Security income. These withholdings are treated by the IRS as if they were made evenly throughout the year, even if they happen late in the year.
Paying estimated taxes may not be the most exciting part of your financial life, but it’s a critical one. At Searcy Financial Services and Allos Investment Advisors, we help coordinate with our clients’ accountants to determine the best plan for withholding, estimated tax payments, and sources of income to support lifestyle in retirement.
If your income fluctuates or you’re unsure whether you’re on track, let’s talk. A few smart adjustments now could give you peace of mind later and help you stay focused on what matters most.