Like most of us, the IRS likes to receive a steady stream of income, and we are required to pay a steady stream of taxes during the year. For wage earners, this is accomplished through payroll withholding. For independent contractors, quarterly estimated tax payments must be made. I’ll refer to both of these as pre-payments. At year end, your final tax bill is calculated and hopefully you will have pre-paid enough to more or less cover your final tax liability. The IRS is happy as long as you pre-pay at least 90% of tax due, or 100% of last year’s tax. If not, you will be charged a penalty. California has similar requirements. The correct amount to pre-pay, therefore, requires some attention.
We have 2 tools to manage our pre-payments. For wage earners, Form W-4 gives us great flexibility to control how much is withheld. We can change this any time, and even periodically supplement our withholding by paying estimated tax to cover unanticipated income (such as a stock sale). For non wage earners such as contractors, most income probably arrives without any withholding, and you are on your own to make estimated tax payments.
To pay estimated tax, send in your payment with IRS form 1040-ES 4 times/year. Each payment should cover the tax due on income received in that period. The due dates are 4/15, 6/15, 9/15, and 1/15. Again, the goal is to pre-pay >90% of tax due or >100 % of last year’s tax.
How do we know how much to pre-pay? Start by looking at last year’s return. A safe baseline is to pre-pay ¼ of last year’s tax for each estimated tax period. Then look at changes in income and deductions for each estimated tax period and adjust accordingly.
If insufficient pre-payments are made, you will be charged penalties on the underpayment. Like most things IRS, the rules defy simple explanation, so I did a “what if” calculation on a real client’s tax return, creating underpayments of $10000 (federal) and $2000 (state) for the 6/15 due date. The resulting penalty was $460 federal and $96 state, both roughly equivalent to a 7% annual interest rate. This is only a single data point using 2025 rules, but should serve as a rough guide.