Minimizing your income tax bill is an important part of your financial plan. Many physicians either coming out of residency or moving from an employed position to one as an independent contractor or partner aren't aware of the need to pay quarterly estimated taxes. Even worse, many doctors don't realize the difference between the amount of taxes that are withheld and the amount owed. These numbers can be quite different.
What You Need to Know about Estimated Taxes and the Safe Harbor Rule
Taxes Withheld Do Not Equal Taxes Owed
I always get a kick out of people excited to get a big tax refund. “Tax refund sales” pander to the financial ignorance of our nation. These fools rejoice in the fact that they got to loan the government their own money interest-free for a period of up to 16 months!
Instead, your goal ought to be to pay as few of your taxes as possible until the last possible moment without owing any penalties or interest. An employee does this by selecting an appropriate number of allowances on his Form W-4. An independent contractor or a partner does this by paying an appropriate amount with his quarterly estimated tax payments. But either way, the amount withheld or sent in with estimated tax payments may have little to do with the actual amount of taxes owed at the end of the year.
Quarterly Estimated Payments
Since no one is withholding your taxes anymore, you are responsible to pay them yourself. This includes your federal income taxes, your payroll taxes (Social Security and Medicare), your state income taxes, and if incorporated, your state and federal unemployment insurance payments.
These quarterly payments must be post-marked by April 15th (of the current year), June 15th, September 15th, and January 15th. State deadlines often differ slightly and the payments are sent to the state tax commission instead of the US Treasury/IRS, but the principle is the same. Instructions for how to do this can be found on IRS Form 1040-ES.
There are a few exceptions to the need to make payments, but most doctors don't meet them, except possibly in their first year as an independent contractor/partner. To avoid making quarterly estimated tax payments you need to either owe less than $1000 total for the year (fat chance of that), have had 100%-110% (requirement is higher if you have more than $150K of income) of what you owed the previous year already withheld prior to transitioning from employee to independent contractor, or have already had 90% of what you owe for the current year withheld. I came very close to this situation this year (my first making estimated tax payments) so I know it is quite possible for a doc.
The 3 Big Tax Mistakes
There are three big mistakes to avoid when paying taxes.
#1 The first, least serious mistake, is to pay your taxes earlier than you have to (or pay more than you owe in the first place.
#2 The second, more serious mistake, is to not pre-pay a high enough percentage of your taxes and thus owe penalties and interest (not to mention the taxes themselves.)
#3 The third, and most serious mistake that commonly gets people into tax trouble with the IRS, is to spend your tax money on something besides taxes, so that when April 15th comes around you don't actually have the money to pay the taxes.
Understanding the safe harbor rules will help you avoid the first two problems. Understanding the tax code and being disciplined will help with the last.
Safe Harbor Rules
The tax system is a pay-as-you-go system. You can't just wait until April 15th and pay your tax bill. If you do you'll owe penalties (1/4 to 1% of the amount owed for each month it is owed) and interest (at the rate of the federal short-term rate– currently around 0.25%- plus 3%). But you can make a big payment on April 15th without paying penalties or interest IF you qualify under one of the following safe harbor rules.
- You didn't owe any tax at all last year. (Good luck with this one.)
- You underpaid by less than $1000. (So basically you never want to pay that last $1000 you owe early.)
- You underpaid by less than 10% of what you owe this year. (Again, no point in ever paying more than 90% of your tax bill prior to April 15th.)
- You paid in, either through witholding or via estimated tax payments, at least 100% (110% if you made over $150K) of what you owed last year. (More on this below.)
You may also be able to avoid the penalties (but not the interest) if your underpayment was due to disaster, casualty, other unforeseen circumstance, disability or even retirement, if you can show the underpayment was due to reasonable cause and not willful neglect.
The 110% Rule
Estimating your taxes isn't necessarily easy, especially when you have a variable income like most physician independent contractors or partners. Doctors rarely qualify under rule 1, and rules 2 and 3 require you to somewhat accurately estimate your current tax bill. So rule 4 is really the only safe harbor that most physicians can actually count on. Take what you owed last year, multiply it by 1.1, then divide it by four, and send in a check for that amount every quarter.
If you transitioned from an employee position midway through the year (like most docs), it can be even trickier. You take what has been withheld so far for you, subtract that from the amount owed last year multiplied by 1.1, divide by two, and send that amount in on September 15th and January 15th.
Unequal Payments
So, you're thinking to yourself, why not just send in all the money on January 15th? Unfortunately, the IRS is one step ahead of you. Your payments throughout the year have to be related to your income throughout the year, as you can see on Form 2210. Interestingly, if you have the money withheld by an employer, it doesn't matter when it was withheld. You can claim 50 allowances all year, then claim 0 in November and December, and if you otherwise fall into the safe harbor rules, no penalties or interest are owed!
Remember To Keep Your Tax Money Safe
If you pay less than you owe, either deliberately or accidentally, be sure to keep enough cash on hand to pay those taxes come April. Remember that taxes withheld/pre-paid may have little to do with the taxes actually owed, and come April 15th, you've got to square the accounts.
So say I start moonlighting halfway through next year of residency. Instead of paying estimated taxes in January, before I even start moonlighting, I can wait until September and then start paying quarterly taxes (effectively in September and January of the following year). My total amount for that year will be paid in 2 installments as below:
[(1.1 x last years tax amount) – (amount already witheld this year)] / 2
That sound about right? I was trying to wrap my head around this earlier and couldn’t understand how I was expected to pay, with money I don’t have yet, taxes on my mooonlighting I won’t be doing until halfway through the year.
I love your blog! Thanks!
~Jeremy
You could do that. Or you could just have a little more withheld from your residency paycheck to cover the additional taxes that will be due. You could even wait until late in the year, then change your W-4 to have more withheld after you estimate your taxes.
Whitecoat, you never have to do quarterly payments if you are both a w-2 employee, and have never had to pay underpayment penalties (or said another way, you have always met safeharbor requirements). I am now 6 years out from residency, and have always witheld extra on my last paycheck as needed as a largely w-2 s corp partner owner. So not paying quarterly estimated payments is relatively easy in my situation.
Do I understand this correctly: I finishing residency this year, last year my required taxes were $1306. I am getting paid this next year both a salary as an employee (of the group I joined) and recruitment incentives as an independent contractor (from the hospital). So long as I have withheld 100% of last years return (which will be very easily done) I do not have to pay quarterly taxes on the amount I received as an independent contractor? I will then be required to pay (without penalty) the actual taxes owed in a lump sum next April?
WCI – in prioritizing some financial tasks as the year closes, I have been thinking about taxes and came across this in the archive.
I wanted to take the chance to thank you for this well written article regarding tax withholding and safe harbor rules. In addition to applying it to physicians, you do a great job of explaining a complex topic in a very easy to understand way.
Thanks for all the great content.
Due to my tax situation (rising taxable income nearly every one of the last 13 years, 8 of which involved self-employed income,) I’ve become very familiar with the safe harbor rules. At this point I basically just take what I owed last year, add 10%, divide by four, and pay that as my quarterly estimateds. Then I have a big tax payment due the next April, but no penalty.
WCI- I second the above comment, and have an additional question. I am active duty military (W2, obviously), and I am planning to start moonlighting this year (1099), likely around June-July time frame. My plan was to transfer 1/3 of each moonlighting paycheck to a “tax holding account” and send that in as quarterly payments. Does this seem like a safe option? My concern is that I have no idea how variable my moonlighting income will be, so I don’t want to get hit with a penalty if I can avoid it, but I also don’t want to loan the government my money if I don’d need to!
I would’t pay more in quarterly estimateds than the minimum required to stay in the safe harbor (which might be zero given you’re just starting moonlighting) but I would then pay the 1/3 into your savings account and wait and see what you actually owe. It was ridiculous how high my marginal rate was in the military. I was in the 25th percentile, perhaps a taxable income of something like $50-60K but my marginal was 25% federal + 6% state + 12.2% SS + 2.9% Medicare. It was 40-45% marginal on a taxable income of less than $100K.
Just to confirm. If you are paid on a W2 and K1 and wanted to pay estimated taxes by withholding from your W2 you would just withhold 110% of last years taxes paid/12 months rather than paying every quarter? Either is acceptable?
Hi WCI – I started work as a locum this year and also receive a yearly W-2 as a resident. I received federal and state returns for 2015 (didn’t owe anything last year). Because of this, am I exempt from quarterly payments?
https://www.irs.gov/publications/p17/ch04.html#en_US_2015_publink100032383
If you truly didn’t owe anything (which I doubt) then yes, you are exempt this year.
Who Doesn’t Have To Pay Estimated Tax
If you receive salaries or wages, you can avoid having to pay estimated tax by asking your employer to take more tax out of your earnings. To do this, give a new Form W-4 to your employer. See chapter 1 of Pub. 505.
Estimated tax not required. You don’t have to pay estimated tax for 2016 if you meet all three of the following conditions.
You had no tax liability for 2015.
You were a U.S. citizen or resident alien for the whole year.
Your 2015 tax year covered a 12-month period.
You had no tax liability for 2015 if your total tax was zero or you didn’t have to file an income tax return. For the definition of “total tax” for 2015, see Pub. 505, chapter 2.
I realize how horribly incorrect I was in my statement. What I meant to say was that my 2015 withholdings were greater than that of my total tax in 2015. In 2016, I have maintained the same withholdings but took up this part time locum job while finishing residency. Given this scenario, am I still exempt from paying the feds q4mo?
If the amount you have withheld this year is equal to 110% of what you owed last year, then you’re good. Otherwise, I don’t see why you would be exempt from quarterlies (which aren’t Q4 months, they’re not even Q3 months, they are April, June, September, and January.)
Just to make sure, is the 110% of total last year taxes (state and federal) or just one of them? Also I assume you must make at least 2 pre-payments (Sept and Jan) to not cause an issue with waiting too long? I am transitioning to my first attending job this year with additional 1099 income from stipend. I owe a 57 dollar fee for taxes this year because I didn’t pay enough in when considering my stipend. Trying to avoid this going forward.
110% of last year’s federal taxes. You’ll have to read your state tax rules about safe harbors. In Utah, you don’t have to make estimated state quarterly taxes at all.
Also is the 150k rule for the prior year or for the current year. For example my AGI was ~135k in 2016, this year I will be over 150k for 2017. Do I need to safe harbor 100% of my 2016 taxes or 110%? Thanks for all your help.
Great question. 100%. Next year it’ll be 110%.
https://www.irs.gov/publications/p17/ch04.html#en_US_2016_publink100032402 (at the very end)
Awesome, thank you so much. I would be lost without this site.
That seems unlikely, but it probably helps you learn a little faster than you otherwise would.
We use a simple spreadsheet for my wife’s LLC that estimates her taxes and we got a big 2015 refund (in other words, we overpaid, although there were some other reasons – multiple W-2’s, specifically – the refund happened as well).
I’m a little anxious about this year because we have definitely underpaid the 110% Rule. My wife took maternity leave and thus her income was lower in 2016 then 2015, so I know we don’t owe as much and the 110% rule isn’t accurate, but I’m worried that our spreadsheet may not work as well in our favor this year (not sure why I’m worried, just am).
I guess I’m just pointing out that the 110% rule can be hard to do if you have a significantly decreased income from the prior year, and then the “estimating” part becomes pretty important. We’ll find out soon if we made the right payments or not. Fingers crossed.
Yes, you’ll have to estimate. But there is some wiggle room. As long as you paid at least 90% of what you owe this year you’re still okay. And even if you’re not okay, the penalty isn’t that large. It’s not like they lock you up.
So I am not a physician but work in the medical field. I have itemized deduction due to my driving a lot for work (about 3500 miles a month). Thus I typically get a tax return due to the miles and other tax exemption methods I use (hsa/deferred tax ira etc). What would be your recommendation of allowances on my w-4? I am married with a kid. I currently claim 3…?
Thanks!
Kyle
If you keep getting money back sounds like you need more. You can certainly claim 4 as that’s what you should be claiming on it, no?
WC, I went through the comments to see if any of this applied to my situation and I didn’t see anything so I am going to tell you my predicament and see what you think. This summer I started my one-year fellowship and signed with a private practice group that gave me a 10k signing bonus and a 4k/month stipend starting Aug.1 and extending until July 1. I received a check for the signing bonus, and the rest is deposited into my account. They obviously didn’t withhold anything from it so I will have to pay taxes on it this coming year.
Should I have been paying taxes on this money they have given me RIGHT NOW? Or is it just going to come due on April 15th? I figured that roughly they would want 30% of that money which equals 9k (30k*0.30). If I am supposed to pay in installments, how do I go about doing that? I guess I kinda figured that I wouldn’t be getting any money on my tax return and that I would just have to make up the rest of it with savings. Let me know what you think and anyone else who has comments or suggestions. Thanks for the help
JM
Yes, you’ll owe taxes on the money. Whether you will have to a pay a penalty if you don’t send in quarterly estimated taxes is an entirely different question. If you pay 110% of what you paid last year (between what your employer withholds and what you pay as quarterly estimated taxes), you should be able to avoid any penalties, although you may still have to pay more next April.
Why not make 1 large “quarterly” payment by Jan 15 (last quarterly tax payment due date) to bring your tax liability to within $1,000 (safe harbor) and then not owe any penalty come tax day? This way you hang on to your money as long as possible throughout the year. Won’t the fact that you didn’t make 4 payments throughout the year (like you should) be a moot point if you establish the safe harbor criteria? Am I missing something?
Go ahead and try and see what happens. 🙂
If you’re not making 4 equal payments, there’s a form you fill out that’s a pain in the butt that basically makes sure you pay as you go. I just make 4 equal payments to avoid the issue.
I did a little digging and think I found the solution!
The IRS treats estimated quarterly taxes different than paycheck withholding. Estimated tax payments are considered paid when paid while income is annualized. But, withholding tax is considered paid equally all year, regardless when actually withheld! If you make as estimated payment at the end of the year, you still get a penalty for not making payments earlier in the year. But, if you increase your W-2 withholding at the end of the year (e.g. December paycheck), the IRS says you made those payments equally throughout the year, avoiding the underpayment penalty.
source: https://wealthyaccountant.com/2017/03/22/stop-paying-your-quarterly-estimated-taxes/
Correct. To take most advantage of this you could consider under-withholding from W2 wages early in the year, then “catch up” by increasing withholding at the end of the year, and only withhold enough to meet the safe harbor.
If you have an S Corp, you can do that yourself by only paying yourself in December (and thus only withholding in December). You might get some funny questions from the IRS though.
Does the 110% rule apply to a couple , married filing jointly? Do I take into account our combined taxes and pay 110% of last year’s amount if I am using that rule? Or does it just apply to me as an individual (my wife has a w2, I have a w2 and k1 from last year). Thanks
As always, appreciate the excellent articles.
Yes.
Thanks for all the information. A couple questions just to clarify. I’m a resident and plan on starting moonlighting this year.
1) Since every year my salary goes up slightly and my employer withholds for tax bill, I should by definition be already withholding this year 100% of what I owed last year correct? I don’t need to ask them to withhold extra – (though i may do this just to not owe a bunch from my moonlighting gigs).
2) If I withhold extra on my W-2 position, will that be used to pay what I owe for my 1099 job?
3) How do I (or the government) know that I am even using the safe harbor rule? Do I still need to send something in every quarter saying that I don’t need to pay? Or do they just automatically figure it out for the taxes due in April and let me know whether i qualified?
Thanks!!
1. Not necessarily, but probably. What is withheld and what is owed are two separate numbers.
2. Yes.
3. The tax forms/software do it automatically when determining whether you owe a penalty or not. If you want to work through it by hand, here’s the form: https://www.irs.gov/pub/irs-pdf/f2210.pdf
I started moonlighting halfway through last year. In 2020 I plan to pay 100% of my 2019 federal tax bill in four installments (AGI<150k as a resident). However, my 2019 state tax bill resulted in a small refund. Can I safely avoid paying quarterly estimated taxes to my state in 2020? Since I do not plan to increase my W2 withholdings I expect to be hit with a (manageable) state tax bill this time next year, but I want to ensure I will not be subject to penalties. Thank you!
Hey WCI,
Thanks for all you do! I’ve been searching all over the internet for reliable information about this topic and of course had to look no further than your archives to find the topic. I saw in the comments that you have avoided form 2210 because a) it appears to be a huge pain, and 2) you have had steadily increasing income each year (congrats!). I have a question about my situation that is making me consider going through the hassle of form 2210, but wanted to get your thoughts on it, if you don’t mind:
I transitioned from W-2 to K1 in January (one paycheck was W2, but rest will be on K1). My income should hopefully increase this year, but of course that is hard to predict this early in the year (I’m guessing it won’t be drastically higher than last year). The way we work is that I take a “salary” and the rest is paid out as quarterly bonuses. My salary draw is <75% of what I will likely make this year. As such, the 110% rule is going to make my first quarter estimated tax payment really hurt as it is probably going to be ~50% of what my take-home pay has been the last 3 months. Of course, it should all even out in the wash over the next 9 months, and I technically have the cash on hand to swing it, but is making me draw down my savings more than I would like.
Do you think it is worth it to just suck it up, pay the equal payments, and just be tight for a month until I get April's paychecks and Q1 bonus, or is the form straight forward enough that I could do it (or pay my accountant to do it) without to much risk of screwing it up? I certainly would be happy to provide specific number if that would help. Thanks again!
The form isn’t that bad. Go ahead and try it. Worst case scenario, you pay a little interest.
Hi WCI,
Does the 110% of last year’s withholding include Social Security and Medicare or is it just federal income?
Thanks
Depends. Yes if you’re paying it as “self-employment tax.” No if it being withheld by employer.
My accountant is not timely in responses and looking for new one. So I have to do quarterly taxes myself.
I have filed extension till Oct due to multiple K-1s. I’m assuming I should base quarterly taxes on total amount of tax I have payed for the 2020 tax year, even though 2020 tax filings are not complete? I did estimated taxes with her last year.
Yea, tricky eh? I’m in the same boat. Total guess on my quarterly payments this year and I just scheduled the second one.
As my accountant is MIA, I will be doing this myself. I settled on using the 110% rule as detailed in your article.
I took my accountants 2020 1040-ES sheet with my estimated tax due for that year and multiplied it by 1.1. Subtracted by current W-2 federal tax withholding and estimated withholdings for the rest of year based on current salary. Took the remainder and divided by four for the quarterly tax. Did the same for state tax using 100% of 2020.
Sounds about right to me based on IRS rules?
Sounds like a pretty good guess. Just remember that’s what it is so keep track a bit throughout the year and if it seems you are dramatically under make larger estimated tax payments for Q3 and Q4.
This may be a silly question, but I am filing quarterly taxes for the first time for some independent contractor locums work that I did in 2021. I have submitted my estimated payments online for federal and state, do I need to send in copies of my 1040 ES worksheet? Or is my payment sufficient until annual returns in April?
The EFTPS payment is sufficient. All that is on the form is already in EFTPS. Your payment was filing the form.
WCI thanks for the info.
I have a W2 job with similar pay year over year. I started a side gig IC job this year. I am trying to make sure I have this right. Given this is my first year with side gig, I don’t really have to pay anything in quarterly taxes from my earning as IC because I only need to pay 110% of what I owed from my W2 job last year which I can just do by increasing withholding to add up to that 10%. I will be putting away about 40% of my earnings from my side gig into a savings account, but won’t send that as quarterly payments because I don’t need to do that given this is my first year?
Next year my IC job will added to my taxes so my quarterly tax payment will be much higher. Is that correct?
Sounds right. 40% is probably a little high, no? And yes, you’ll likely need to do quarterly estimateds next year.
Thank you for this post and your comments!
I am making w2 income and additional 1099 moonlighting income. Last year I made approximately $20,000 extra in moonlighting and had to pay an additional~$4500 for the 2021 tax year due to the moonlighting income.
2022 will be the first year I will be making quarterly payments. I recently submitted my first quarterly payment of ~$5500 just before the april 18 2022 deadline, which I did on a very overestimated guess of what I would make in additional moonlighting income.
Because I overestimated my expected income by quite a large margin, i am wondering if now because i already paid over 110% of the previous years tax liability, would I be in the safe harbor already and no longer required to make any additional quarterly payments? Additionally, does that mean I would avoid filing form 2210? (I do expect to make more moonlighting income this year than last year, but not to the overestimated amount when I tried to calculate my actual tax burden).
You haven’t paid 110%. Remember that applies to ALL of your income. But sounds to me like your moonlighting income is low enough that you could just adjust your withholdings at the W-2 job and cover the difference and may not need to make quarterlies at all.
If there’s no underpayment, you don’t have to file 2210.
If you’re going to be in the safe harbor with just your witholding and that single payment, no, you don’t have to make any more payments and I wouldn’t expect you’d have to file 2210.
Hi there,
We file our own taxes and realized a little late that we should be paying these estimated tax payments. I’m trying to figure out if I should go ahead and just pay now the two that we missed as one payment or if I need to pay them as 4 equal payments? So, for example I could pay one this week, one next week and then the other two when they are due. Does it matter? Will I cause myself problems if I just make one bigger payment now and then the other two smaller payments when they are due? Thanks for your help! We love WCI!
The sooner you pay, the lower your penalty. One big payment should be fine, but expect a penalty (really just interest on what you should have paid earlier) this year.