Estimated Tax Definition
“Estimated Tax” is the approximately calculated tax to be paid by an earning individual eligible to pay taxes over their income. This amount is estimated annually based on the net income earned by the individual after all deductions as per the income tax act prevalent in a particular State for that fiscal year.
Estimated tax refers to a self-paid tax which is determined by the assessee from the income they have received or expected to receive by them during the financial year and consequently they deposit such tax on estimation without invoking the provisions of withholding of taxes.
Income may include salary receipts, capital tax gains, interest income, dividends, and coupon receipts, self-occupation or any other form which adds to the net amount available with the individual/ company. Individuals (or companies) with unequal monthly income may annualize their income in order to calculate the total income received during the year.
Estimated Tax for the Year = (All Postive Income including gains – allowed deductions) x Tax Rate
In the U.S., individuals may use Form 1040(ES) in order to calculate their taxes, while corporations may use Form 1120-W for the same.
It must be rightly intended by the taxpayer to disclose all incomes and deductions and calculate this amount accurately, in order to avoid last minute penalties or other severe consequences. In the case of excess tax payments, the amount can be recovered after the end of such fiscal year at the time of return filing.
Federal Tax brackets for 2019:
Estimated Tax Calculation with Examples
John works for ABC Corp and earns $100,000 annually. He has been paying $1,000 as withheld taxes each month to his company. He has a child whose expenses are $5000. He has invested in T-bill securities which are projected to earn him an income of $2,000 during the year. Calculate the estimated tax to be paid for the current year by John.
- Based on the income, John falls under the bracket of 24%.
- Hence, 24%* $85,000 = $20,400.
- John has to pay tax of $20,400 annually (or $1,700 per month).
In the above example, consider the below-added information for John and re-estimate the taxes to be paid by him:
- Education loan of $30,000.
- Interest expenses of $30,000
- Medical Expenses: $5,000
John falls into the bracket of 12%. Hence Taxes to be paid = 12% * $20,000 = $2,400 annually
- It forms a major source of revenue for the government. If this element of financial returns from the nation is missing, then a major impact is made on planning and development.
- This kind of Taxes also help individuals plan for their future. This helps them understand what is their actual spend, actual saving, and how they can accordingly plan for their other commitments.
- These payments to the Government help in future projections and estimates for the economy. It helps in major planning and execution decisions for the Government.
- Paying a lump sum at the end of the year or semi-annually may get difficult while paying the same amount in monthly installments seems a better option for salaried individuals. This helps them to make their monthly projections better.
- Maintaining accounts get easier if timely and best-estimated taxes are paid. This enhances the productivity and transparency of the company.
- Paying such taxes strengthens the credibility of a tax-payer. This may further help them in opting for debt or other investments.
- Timely payment of taxes helps avoid penalties and/or severe consequences.
- If paid quarterly, this amount can be saved and invested in other avenues and hence can generate additional income to the taxpayer.
- There are quite some examples of individuals and companies who evade the payment of taxes. This distorts the supposed returns from the nation for the Government.
- Individuals may pay such taxes on time; however, the correct figures should be reported during the calculation. If there is a gap in the calculation, incorrect estimates are being used for payment.
- There is hardly any medium of verification of real payments supposed to be made by individuals and companies.
- This is still an estimated amount of taxes to be paid. Chances are that tax-payers may make false commitments and try to evade the actual tax amount.
- Verification of actual documents submitted by the tax-payers takes quite a while due to which there is a time value of money difference.
- Income tax rates are static for the year. If the annual income changes during the year, such taxes cannot be changed for the year. The tax-payer still pays the same amount as he did in the beginning.
- It is paid by any individual and corporations if their income increases by more than $1,000 and $500 respectively for the year after all deductions. This amount varies depending upon the financial activities done by the taxpayer during the year.
- With every year, there are new tax brackets created by the Government based on the movement and circulation of money in the economy. It also depends on the nation’s growth and other economic factors.
This is supposed to be paid by all individuals once they are in the eligible criteria. Payment of such taxes should be done accurately and in a timely manner since otherwise it may attract a penalty. Based on the deductions allowed under the IRS codes, the amount needs to be calculated and after the end of the particular fiscal year, reconciliation needs to be done by filing returns. The net tax amount calculated may be positive or negative, which then needs to be paid by the individual in case of positive and vice-versa.
This has been a guide to what is Estimated Tax and its Definition. Here we provide the formula and steps to calculate the Estimated tax along with practical examples, Advantages, and Disadvantages. You can learn more about Accounting from the following articles –