The vast majority of real estate agents and brokers are self-employed. One thing that’s great about being self-employed is that you don’t have any taxes withheld from your pay. As a result, you may have higher take-home pay than employees earning similar amounts.
Unfortunately, however, self-employed workers do not have the luxury of waiting until April 18 (the usual April 15 deadline has been extended three days this year) to pay all their taxes for the previous year.
The Internal Revenue Service wants to get its money a lot faster than that, so the self-employed are required to pay taxes on their estimated annual incomes in four payments spread out over each year.
These are called estimated taxes and are used to pay both income taxes and self-employment taxes (Social Security and Medicare tax).
Because of estimated taxes, you need to carefully budget your money. If you fail to set aside enough of your earnings to pay your estimated taxes, you could face a huge tax bill on April 15 — and have a tough time coming up with the money to cover it.
Who must pay
You must pay estimated taxes if you are a sole proprietor, partner in a partnership or member of a limited liability company and you expect to owe at least $1,000 in federal tax for the year. If you’ve formed a C corporation, it may also have to pay estimated taxes.
However, if you paid no taxes last year — for example, because your real estate business made no profit or you weren’t working — you don’t have to pay any estimated tax this year no matter what your tax tally for the year.
But this is true only if you were a U.S. citizen or resident for the year and your tax return for the previous year covered the whole 12 months.
How much to pay
Most people want to pay as little estimated tax as possible during the year so they can earn interest on their money instead of handing it over to the IRS. However, the IRS imposes penalties if you don’t pay enough estimated tax. To avoid penalties, you must pay at least the smaller of:
- 90 percent of your total tax due for the current year, or
- 100 percent of the tax you paid the previous year or 110 percent if you’re a high-income taxpayer.
High-income taxpayers — those with adjusted gross income of more than $150,000 ($75,000 for married couples filing separate returns) — must pay 110 percent of their prior year’s income tax.
The easiest way to calculate your estimated taxes is to simply pay 100 percent of the total federal taxes you paid last year, or 110 percent if you’re a high-income taxpayer.
You can base your estimated tax on the amount you paid the prior year even if you weren’t in business that year, but your return for the year must have been for a full 12-month period.
There are two other ways you can calculate your estimated tax that are more complicated, but might result in lower payments:
If you think your net income will be less this year than last year, you’ll pay less estimated tax if you base your tax on your taxable income for the current year instead of basing it on last year’s tax.
The problem with using this method is that you must estimate your total income and deductions for the year to figure out how much to pay. Obviously, this can be difficult to compute accurately.
A much more complicated way to calculate your estimated taxes is to use the annualized income installment method. It requires that you separately calculate your tax liability at four points during the year — March 31, May 31, Aug. 31 and Dec. 31 — prorating your deductions and personal exemptions.
For this method, you base your estimated tax payments on your actual tax liability for each quarter. This is often the best choice for people who receive income very unevenly throughout the year. Using this method, they can pay little or no estimated tax for the quarters in which they earned little or no income.
If you do your taxes yourself, tax preparation software such as TurboTax can help you calculate your estimated taxes. IRS Form 1040ES also contains worksheets you can use.
When to pay
Estimated tax must ordinarily be paid in four installments, with the first one due April 15 (April 18 this year). However, you don’t have to start making payments until you actually earn income. If you don’t receive any income by March 31, you can skip the April 15 payment.
In this event, you’d ordinarily make three payments for the year starting on June 15. If you don’t receive any income by May 31, you can skip the June 15 payment as well, and so on.
The following chart shows the due dates and the periods each installment covers.
|Income received for the period||Estimated tax due|
|Jan. 1-March 31||April 15 (April 18 in 2011)|
|April 1-May 31||June 15|
|June 1-Aug. 31||Sept. 15|
|Sept. 1 through Dec. 31||Jan. 15 of following year|
How to pay
The IRS wants to make it easy for you to send in your money. You can pay by check, electronic payment, or even by credit card (but if you pay by credit card, you must pay a service fee to a private company). For details, check out IRS Publication 505, Tax Withholding and Estimated Tax.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including “Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants,” “Deduct It,” “Working as an Independent Contractor,” and “Working with Independent Contractors.” He welcomes your questions for this weekly column.