What is the Formula for Estimated Taxes?

If you’re self-employed, a freelancer, or earn income outside of traditional W-2 wages, chances are you’ve heard of estimated taxes. Unlike employees who have taxes withheld automatically from their paychecks, individuals with untaxed income must calculate and pay taxes directly to the IRS each quarter. But how exactly do you figure out how much to pay? That’s where the estimated tax formula comes in.

The formula for calculating estimated taxes is:

Estimated Tax = [(Income – Deductions) × Tax Rate] + Self-Employment Tax – Credits

Let’s break this down step by step:

1. Income – Deductions

First, you calculate your taxable income. This is your total income from all sources (business earnings, side gigs, rental income, etc.) minus any deductions you’re eligible for. Deductions can include things like the standard deduction, business expenses, retirement contributions, and health insurance premiums for self-employed individuals.

2. × Tax Rate

Once you have your taxable income, you apply the appropriate tax rate. The U.S. uses a progressive tax system, which means higher income is taxed at higher rates. However, for estimating taxes, many people use an average or effective tax rate as a rough estimate—often somewhere between 10% and 30%, depending on their total income.

3. + Self-Employment Tax

If you’re self-employed, you’ll also need to pay self-employment tax, which covers Social Security and Medicare taxes. The current self-employment tax rate is 15.3% (12.4% for Social Security and 2.9% for Medicare). You calculate this tax based on 92.35% of your net earnings, not your gross income.

4. – Credits

Finally, subtract any tax credits you’re eligible for. Credits directly reduce the amount of tax you owe and may include things like the Child Tax Credit, education credits, or energy-efficient home credits.

Example

Let’s say you earned $50,000, had $10,000 in deductions, use a 20% tax rate, and owe $7,000 in self-employment tax, but have $1,000 in credits.

Estimated Tax = [($50,000 – $10,000) × 20%] + $7,000 – $1,000 Estimated Tax = [$40,000 × 20%] + $7,000 – $1,000 = $8,000 + $7,000 – $1,000 = $14,000

Paying estimated taxes accurately helps you avoid IRS penalties and surprises at tax time. Always consult a tax professional if you’re unsure!