If you have a steady income you pay taxes continuously based on the assumption of the final income per year. However if your income is very spikey you may have no idea how much you will be making in a given year. You still have to pay estimated taxes to avoid a penalty but how do you estimate?
I was wondering if the following approach will avoid the penalty: pay estimated taxes every time you generate income under the assumption that there will be no more income for the rest of the year. An example: let's say you make $120k/year. Tax would be around 12k (married, jointly). If you are on a salary you would simply pay 3k per quarter.
Now if you are a freelancer and make 30k in the first quarter but have no clue how the rest of the year will look like, how much estimated taxes do you need to pay? If 30k is your only income, you would only have to pay $520. If you keep making 30k/quarter, you would pay 3.3k in Q2 3.6k in Q3 and 4.3k in Q4 for a total of 12K. If you make nothing in Q2 and Q3 and 90k in Q4 you'd pay nothing in Q2 and Q3 and 11.5k in Q4. It's still the same total but it's paid less early in the year and more later in the year. It's paid when the income happens.
In the scenario described I would have paid $520 in Q1 and not $3000 that I should have paid. Question: Would that incur an underpayment penalty ?
- I can not pay 110%/100% of last years taxes since that would be a gross overpayment
- I DO pay 100% of this year's taxes. The question is not about the total amount but about the sequencing and timing of the payments.