Are estimated taxes really estimates? Or taxes?

They're not taxes and not exactly estimates either.

Think of them as prepayments and all taxpayers are required to make them. If you have a job, your employer withholds federal income tax from each paycheck. Withholdings are prepayments.

However, if you are an independent contractor, you don’t have an employer to withhold taxes. So, you must make direct payments to the IRS. Those are known as estimated tax payments.

The prepayment requirement applies to anyone who will owe more than $1,000 when they file their tax returns. Here are some examples:

  • You have a job but your federal taxes are under-withheld. Maybe you claimed too many withholding exemptions.

  • You have a job and are also self-employed and your withholdings don’t cover all of your federal income and self-employment taxes.

  • You have income where there are no withholdings. For example, interest, dividends, rent and capital gains.

Tip: You may be able to avoid having to estimate your taxes and make estimated tax payments by adjusting your withholdings. 

  • Use the Form W-4 to ask your employer to withhold an additional flat-dollar amount each pay period. 

  • If you have retirement income, you can often choose to have federal (and sometimes state) taxes withheld from pension, 401(k), IRA and Social Security payments. 

What happens if you don't prepay the required amount? There can be a penalty. 

Important. Many states also have estimated tax requirements.

Also read How can I minimize the estimated tax penalty?