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If you are self-employed or expect to generate significant income this year from investments or from the sale of real estate, then you probably will have to pay estimated taxes for 2008.

What are estimated taxes?

Well, the Internal Revenue Service wants you to pay at least 90% of your tax liability by the time you file your taxes April 15. If you get paid as an employee, your employer handles prepayment of federal and state taxes by withholding a portion of every paycheck. But if you are self-employed or a sole proprietor, you must account for that prepayment on your own.

Here's what you need to know about how to do it:

Who Needs to Pay

First, consider the following questions:

  • Will you owe at least $1,000 in taxes for 2008, after accounting for any withholding or credits?
  • Will any withholding and tax credits amount to less than 90% of what you're likely to owe on April 15, 2009?
  • If you file jointly and have adjusted gross income (AGI) of $150,000 or less, or file singly with AGI of $75,000 or less: Will withholding and tax credits for the upcoming tax year be less than your total federal tax bill on April 15, 2008? If your income exceeds those levels, will withholding and credits be less than 110% of your tax bill on April 15, 2008?

If you answered yes to all three questions, you must make estimated tax payments in 2008.

For example, say your AGI in 2007 was $80,000, and your total federal tax liability was $15,000. In 2008 you expect your AGI to rise to $110,000 from a combination of self-employed and employee income, resulting in federal taxes of $20,000. You arrange for your part-time employer to withhold $10,000 over the course of the year.

The $10,000 withheld by your employer amounts to less than 100% of your $15,000 2007 tax liability, so you will be required to make estimated payments. You could avoid paying estimated taxes if you arranged for your employer to withhold at least $15,000 -- but you will probably owe $5,000 on April 15, 2009.

How Much to Pay

By far the easiest method for making estimated tax payments is to make four equal payments totaling 100% of the previous year's overall tax liability. For example, if your total tax liability for 2007 was $12,000 and you expect to have no withholding in 2008, you would make four payments of $3,000 this year.

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Alternatively, you can calculate your estimated tax payments by first estimating your 2008 tax liability. Use the

IRS worksheet

to help crunch the numbers. You'll need to estimate your total income as well as any adjustments, deductions and tax credits that apply. You'll also have to estimate income from dividends, interest and capital gains as well as business expenses and FICA contributions. (Be sure to check for

changes in the tax code for 2008

that might affect your numbers.)

After calculating your expected tax liability for 2008, you must make four equal payments that total at least 90% of that estimate. For example, if your expected tax liability is $10,000, your payments must total at least $9,000.

The IRS expects you to pay the lesser of the two figures -- either 100% of last year's tax liability or 90% of this year's liability.

When to Pay

Unfortunately, your first estimated tax payment for 2008 is due the same day as your 2007 tax bill: April 15, 2008. The remaining payments are due June 16 (the 15th is a Sunday), Sept. 15 and Jan. 15, 2009.

You will be penalized if you choose not to make estimated payments when you are required to, or if the amount of your payments is insufficient. The IRS bases the penalty on how much you underpaid at each installment -- so underpaying in one quarter will incur a penalty even if you pay the right amount by the end of the year. (You can request to have the penalty waived in certain circumstances, such as an unexpected windfall that occurs late in the year.)

Calculating the underpayment penalty is very complicated: In the instructions on

Form 2210

, the IRS strongly recommends you leave it to them.

Peter McDougall is a freelance writer in Freeport, Me.