Estimated Tax: Part 1 of a 3-Part Series

What is estimated tax, and what do you need to know about it?
May 8, 2013 – TaxTalk Blog

The Indiana income tax system is basically a “pay-as-you-go” system. Employees are familiar with this concept – taxes are automatically taken out of our paychecks every pay day. But what happens if we get income from non-wage sources, such as from interest or dividends, farming, or rental property? No taxes are withheld from these types of income. That said, the “pay-as-you-go” requirement still applies. That’s where estimated tax comes into the picture.

If you have income not subject to withholding tax, or if you don’t have enough tax withheld from your income, you will need to make estimated tax payments if you wind up owing more than $1,000 when you file.

Basically, each year we each close our personal financial books on December 31. Then, we have 3 ½ months (to April 15) to figure how much tax we really owed for the year. If we paid in more than we owed (through withholdings and other credits), we’ll get a refund; if we didn’t pay in enough, we’ll owe additional tax. On rare occasions we’ll break even – we won’t get a refund or owe the state anything.

To figure your estimated tax, you are tasked with coming up with (estimating) how much income you are going to make during the year and then figuring how much tax is due on that amount. There are different ways to accomplish this.

For instance, if you get steady payments each month, such as taxable pension income, then you have a pretty good idea how much pension income you’ll get for the year. For example, if you and your spouse together draw $3,000 a month, you’ll get $36,000 for the entire year ($3,000 each month X 12 months in a year). State tax due on that is $1,224 ($36,000 X .034 [current state tax rate]).

Another example is farm income. It can be challenging to estimate your income when you don’t start seeing those checks come in until the crops and livestock are sold or the rental income comes in. For many, this occurs at the end of the year, and trying to make an educated guess ahead of time can be difficult.

So now the question comes – how can you estimate your income when you haven’t a clue as to how your business will do this year? Or maybe you retired and aren’t sure how the whole tax picture will look.

Well, for this answer, and more information about what you need to know about estimated tax, come back in a couple of days for Part 2 of this three-part series.

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