Voluntary Payments

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Some people prefer to make estimated tax payments even when they aren't required.

Depending on your situation, the amount of estimated tax you're required to pay could be quite a bit less than your true estimate of the amount of tax you'll owe. That's because you're allowed to pay estimates based on the previous year's tax, even if you know this year's tax will be higher. When that happens, you have a choice. You can pay the minimum amount required — and pay the rest on April 15. Or you can pay something close to the true estimate so you won't owe a lot on April 15. Which is better depends on your comfort level and money management skills.

Pay now and relax

Some people choose to make estimated payments even when the payments aren't required. The reason? Perhaps they're concerned that the money won't be there when they need it to pay taxes. Perhaps they're simply more comfortable knowing that they won't have a huge tax bill in April. There are a variety of good reasons to make estimated tax payments even if the payments aren't legally required. The biggest one is peace of mind.

Pay later and earn

The main reason not to pay more than you have to is that you lose the use of your money between the time you pay the estimate and the time you would have sent payment with your return. You should be able to earn at least a little bit of interest during that time. So there's at least one good reason to pay later, even though there are good reasons to pay sooner.

Which is better

Which approach is better — making voluntary payments, or paying the minimum — depends on your personality and your circumstances. Consider the following example:

Example: You normally don't pay estimates because almost all of your income is from wages subject to withholding. In January 2005 you sell stock and have a capital gain of $30,000. You expect to owe $6,000 as a result of this gain. But you don't have to pay estimates because your 2005 withholding will be at least equal to your 2004 tax.

You have several choices, including the following:

  • You can put $6,000 aside in an interest bearing account until April 15, 2005 when the tax is due. This way you can make a little profit on the money before sending it to the IRS. If you have the discipline to leave the money alone, you come out ahead using this approach. There's a danger, though. If you start with this intention, but end up spending the money on a trip to Aruba, or losing it by investing in jelly bean futures, you may wake up with a headache on April 15, 2005.
  • You can send in a single estimated payment of $6,000. This approach is easy, and may seem relatively painless if you do it at a time when you're flush with money from the stock sale. It's also very safe: this approach assures that you won't somehow lose or spend the money before you file your tax return.
  • You can send in four quarterly estimates of $1,500 each. You may prefer this approach if you don't like the idea of writing a single check for $6,000 to the IRS (who does?). And this approach gives you the flexibility to reduce later payments if you have a capital loss or other reduction in taxable income later in the year. There's a little more paperwork involved in this approach though, and more opportunity to lose or spend the money before April 15, 2005.

There's nothing illegal or immoral about any of these approaches. They're all equally acceptable to the IRS. If you find yourself in this situation, you need to make your own decision as to the approach that works best for you.