5/20/2022
California requires self-employed individuals to make quarterly estimated tax payments. This guide explains how you can comply to avoid an underpayment, overpayment or late filing penalty.
Estimated tax refers to the amount of tax you expect to owe for the year. For Californians who have employers, tax payments are usually deducted automatically from their paychecks and sent to the California Franchise Tax Board (CA FTB). This is known as withholding.
But if you are one of the 2.2 million people in California who are self-employed in one way or another1, you will have to file and submit your own estimated payments for the year. The same is true if you are formally employed, yet receive a certain level of income outside of your regular job.
In California, estimated tax is usually paid quarterly. It consists of the current year’s tax less credits that you plan to take as well as tax that you expect to have withheld. This article covers everything you need to know about California estimated tax payments, including minimum taxable income, due dates and applicable penalties for failing to meet your tax liability.
Most of those who are required to pay estimated taxes in California are people in self-employment. Therefore, if you are a small business owner, independent contractor, or freelancer, then you likely have to file your quarterly estimated tax returns. These are essentially people who do not have their taxes withheld by employers.
With that in mind, any income that comes from doing business, dividends, gains from sales of stock, taxable alimony, interest earned, cash prizes etc. is typically subject to estimated tax. As far as residency, you are generally required to file a California income tax return if2:
That said, you are not required to make estimated tax payments if you are currently a nonresident or new resident who did not have a California tax liability in the previous year2. So, if for example, that you moved to California in 2021 as a new resident or nonresident and didn’t have any tax liability in that year. It means that you don’t have to pay estimated tax for 2022 because you don’t have a prior year’s tax.
Additionally, military service members who are not domiciled in California don’t have to pay estimated tax on their military earnings. Non Military spouses of servicemembers may also be allowed to exclude their earnings when computing estimated tax. If you want to confirm whether your pay is excluded from estimated tax on the grounds of being a nonmilitary spouse, make sure to check the FTB Pub. 1032.
In addition to the above, the California Franchise Tax Board has a threshold on the minimum tax amount payable. You are generally required to make estimated tax payments if you expect your tax liability to be $500 or more. The threshold reduces to $250 for people who are married or registered domestic partners (RDP), but filing taxes separately.
Beyond that, you must also pay estimated income tax if you anticipate that your withholdings and credits will either be less than 100% of the prior year’s tax, including Alternative Minimum Tax (AMT) or less than 90% of the current year’s tax – whichever one is smaller.
Say, for example, that your prior year’s tax liability was $1,500 but you expect the current year’s tax to be $1,200:
You will pick the lesser amount of the two – which is $1,080 – and pay that as your estimated tax in four installments. Remember to always include Alternative Minimum Tax in your calculations if it was applicable in the previous year.
California allows taxpayers to pay estimated taxes in four installments. The first thing you will want to do is calculate the total tax due for the current year. As already mentioned, the amount of payable tax is either 90% of the expected current year’s tax or 100% of the prior year’s tax – whichever value is smaller.
Once you know the total tax due, you must pay 30% in the first installment, 40% in the second installment, none in the third installment, and the final 30% in the fourth installment2. As you may have noticed, the amount of tax due in the third installment is zero, which gives you a chance to get current on your tax payments, if you are not already.
While estates, trustees and fiduciaries are not required to file taxes electronically, individuals must use mandatory electronic payments if:
If you meet either of the above thresholds, all your subsequent tax payments must be remitted online via www.ftb.ca.gov. Failure to do so attracts a 1% noncompliance penalty. The CA FTB allows four different ways of making electronic tax payments:
In case you don’t meet the FTB’s e-pay threshold, you may submit your state tax by mail and address it to:
Franchise Tax Board
PO Box 942867
Sacramento CA 94267-0008
Should you opt to pay California estimated tax by mail, fill out form 540-ES for Estimated Tax for Individuals and make out a check or money order to the “Franchise Tax Board”. Make sure to include your Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN) when filling out the form.
It’s worth keeping in mind that there is a separate form 540-ES for every estimated tax installment payment. make sure to use the right form for each installment. For example, don’t use the form meant for the first installment to pay taxes for the second installment. There’s always a payment due date indicated in the top margin of each form to remind you which installment it’s meant for.
Below are the documents that you may use to pay state tax in California if you are self-employed:
As a self-employed person, calculating your California estimated tax payments is not as straightforward as you may want it to be, especially if it’s your first time. The gist of it is that you have to estimate how much money you expect to earn within the year, and then subtract all applicable deductions and credits. That will give you the value of your taxable income. From there, you can now figure out the amount of tax due on that taxable income.
Alternatively, you may use the tax you paid last year as a starting point. This may come in handy if you don’t expect your taxable income to change much. In which case, the FTB allows you to assume that this year’s tax liability will be the same as last year’s. However, since it’s paid in quarterly installments, make sure to adjust and refigure your estimated payments if you find out that you’ve overstated or understated your earnings for the year.
To be on the safe side, consider picking the lesser amount between these two options:
If you earn a high income, you will be subjected to a different standard from the one above. Generally, if your adjusted gross income (AGI) for the current year exceeds $150,000 (or $75,000 if married and filing separately) but is below $1,000,000 (or $500,000 if married and filing separately), then you must pay 110% of the prior year’s tax amount to avoid a California underpayment penalty.
Still on high income taxpayers, if your annual AGI is at least $1,000,000, you must pay 90% of the current year’s estimated tax to avoid an underpayment penalty. Therefore, even before you start calculating your tax liability, make sure to understand whether you are a regular or a high-income taxpayer.
Also, keep in mind that you can always consult tax professionals, public accounting professionals or CPAs if you feel lost about predicting the amount of your tax liability. The other option is using the California Estimated Tax Worksheet found in Form 540-ES. This worksheet works much like the IRS Estimated Tax Worksheet that’s usually found in Form 1040-ES. It will help you calculate the value of your taxable income, after which you may calculate your estimated tax payments.
Generally, to find your estimated taxes, add up all your tax liabilities for the current year – such as individual income tax and self-employment tax. Subtract deductions and credits from the sum you get, and then divide the remainder into four installments as follows:
California estimated tax payments are generally due four times each year:
However, there are a few things worth mentioning. First, if you just started a new business and are not earning just yet, you don’t have to pay any estimated tax until your business generates some income, even if you believe it will do so later in the year.
Secondly, due dates may be affected by public holidays. For example, the deadline for paying the first installment of 2022 estimated tax is April 18 rather than April 15 because the Emancipation Day holiday was observed on the 15th. Therefore, any tax returns filed on or before April 18th are timely and do not attract a penalty. Similarly, the fourth payment is due on January 17, 2023 instead of January 15.
Thirdly, rather than paying the fourth estimate by January 17, 2023, you can calculate your actual tax owed (since you’ll know exactly how much money you earned in 2022) and pay the entire balance due by January 31, 2023. If you do this then you won’t have to pay the fourth installment and you won’t face an estimated tax penalty as long as you pay the full amount due on or before January 31, 2023.
In case your taxable income is not evenly distributed during the year, you may annualize it to lower the chances of an underpayment. The FTB provides form 5805 – Underpayment of Estimated Tax by Individuals and Fiduciaries – for annualization of income.
Finally, if you received at least two-thirds of your AGI from farming or fishing, you don’t necessarily need to pay quarterly tax estimates. You may either pay the full amount of your estimated tax when the fourth installment is usually due (i.e., January 17, 2023 in the case of 2022 taxes), or file your actual tax return on or before March 1, 2023.
If you fail to pay at least 100% of the prior year’s tax or 90% of the current year’s estimate (110% if you are a high income taxpayer), you will be slapped with a 3% underpayment penalty. In addition to that, you’ll be required to pay the full amount of taxes owed (unpaid tax).
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