Why pay estimated taxes?
Same argument and answer for investing instead of paying off debt, or borrowing to invest. Risk. What happens if the stocks drop by 10%? Sure, you might come out ahead on average, but a drop in the market could be catastrophic from a cash flow point of view.  In addition, federal tax debt is arguably the worst kind. The IRS has the authority to garnish wages and has virtually unlimited resources they can use to collect. Your logic is not wrong.  But the risk is more significant than you seem to assume.  Essentially you are proposing taking a 2.6% loan to buy stocks. Is that a good strategy?  On average, probably.  But if your stocks crash you might have significant liabilities. In 1929, the Dow Jones dropped 89%.  In 1989, >30%.  In 2008-9, 54%.  This is a huge risk if this is money that you owe in taxes.  If you operate the same system year after year the chance of it going horribly wrong increases. In addition to the other answers, which cover the risks of what is essentially leveraged investing, I'd like to point out that the 2.6% penalty is a flat rate. If you are responsible for withholding your own taxes then you are paying tax four times a year. So any underpayment on your first quarterly tax payment will have much more time to accrue in the stock market than your last payment, although each underpayment will be penalized by the 2.6%. It may make sense for someone to make full payments on later payments but underpay on earlier ones. While the US tax code does not directly impose an obligation to pay estimated taxes, it does impose a penalty on individuals for failure to pay enough taxes either through withholding or estimated tax. USMTG Anyone can choose how s/he wants to pay their taxes but they better deal with any consequences of not paying them instead of just complaining about it like most people do. Most people get the hatred towards the IRS but most complaints are misdirected and should be directed towards Congress who creates and messes around with the US Tax Code. Some people actually do not make estimated payments and pay any possible taxes with their returns knowing that there may be underpayment penalty. For those people, the penalty is relatively small compared to what they can do with the cash over a year's time (i.e. investing or paying down debt). It's their choice!
You're asking three different questions...  Q1: What's to stop people not reporting income earned in this manner?  A: Nothing. Absolutely nothing. The IRS doesn't have the means to keep track of your cash flow and your reported taxes on the fly.  Q2: How could the IRS possibly keep track of that? A: When you get audited. If it ever did come up that things didn't balance you would end up owing back taxes, with interest and possibly fines.  Q3: Moral obligations aside... why report? A: Since you've dismissed 'doing your duty as a citizen' as a moral obligation, the only other real one is that it's a pain in the butt to get audited and it is expensive if you lie and get caught. Your employer pays the expected (but estimated) taxes for you. So the chances are you don't own more; but that might be different if you have other sources of income that he doesn't know about (interest on savings or a side-job or whatever). Also, you could have deductions that reduce the taxes you owe, which he again doesn't know, so you overpay. If you don't file, you don't get them back. Most tax software companies offer free usage of their tool for standard filings, and you can use it to find out your tax situation, and then buy the tool only when you want to file. If you use one of those, you can type in all your data, and depending on the result, decide to buy it and file right away. Note that if it turns out you owe taxes, you must file (and pay), but of course you can do it manually instead of buying the tool. If it turns out you get money back, it is your decision to file - you probably don't care for a small amount, but if you get 1000 $ back, you might want to file - again, buying the software of doing it manually. "Hearing somewhere is a level or two worse than ""my friend told me.""  You need to do some planning to forecast your full year income and tax bill. In general, you should be filing a quarterly form and tax payment. You'll still reconcile the year with an April filing, but if you are looking to save up to pay a huge bill next year, you are looking at the potential of a penalty for under-withholding.  The instructions and payment coupons are available at the IRS site.  At this point I'm required to offer the following advice - If you are making enough money that this even concerns you, you should consider starting to save for the future. A Solo-401(k) or IRA, or both. Read more on these two accounts and ask separate questions, if you'd like." The purpose of making sure you met the safe harbor was to avoid the penalty. Having achieved that goal the tax law allows you to wait until April 15th to pay the balance. So do so.  Put enough money aside to make sure you can easily make that payment.  I was in this exact situation a few years ago. I planned my w4 to make the safe harbor, and then slept easy even though the house settlement was in May and I didn't have to make the IRS payment unti 11 months later in April. "Not sure I understood, so I'll summarize what I think I read: You got scholarship X, paid tuition Y < X, and you got 1098T to report these numbers. You're asking whether you need to pay taxes on (X-Y) that you end up with as income. The answer is: of course. You can have even lower tax liability if you don't include the numbers on W2, right? So why doesn't it occur to you to ask ""if I don't include W2 in the software, it comes up with a smaller tax - do I need to include it?""?" As was once famously said, Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes. — Benjamin Franklin, 1789 It's very likely that either the company or you personally is going to have to pay taxes on that money. Really the only way to avoid it would be if the company spent that money on next year's expenses, and paid the bill before the end of this year. Of course you can only do that if the recipient is willing to receive their money so far in advance, which isn't necessarily the case since they would pay more taxes this year as a result. As for whether it's better to have the company pay the tax or for you to do as your accountant suggests, there are a lot of factors that go into that equation, and my gut feeling is that your accountant already ran it both ways and is suggesting the better choice. You may be able to find the answers to your question on the IRS web site: http://www.irs.gov/businesses/small/article/0,,id=98263,00.html Specifically, using this form to estimate taxes for salary: http://www.irs.gov/pub/irs-pdf/f1120w.pdf and this form to estimate taxes for dividends: http://www.irs.gov/pub/irs-pdf/f1040es.pdf Either make your best guess, or set it low and then file quarterly Estimated Tax payments to fill in what's missing, or set it high and plan on getting a refund, or adjust it repeatedly through the year, or... Assuming US/IRS: If you filed on time and paid what you believed was the correct amount, they might be kind and let it go. But don't assume they will. If you can't file on time, you are supposed to file estimated taxes before the deadline, and to make that payment large enough to cover what you are likely to owe them. If there is excess, you get it back when you file the actual forms. If there is a shortfall, you may be charged fees, essentially interest on the money you still owe them calculated from the submission due date. If you fail to file anything before the due date, then the fees/interest surcharge is calculated on the entire amount still due; effectively the same as if you had filled an estimated return erroneously claiming you owed nothing. Note that since the penalty scales with the amount still due, large errors do cost you more than small ones. And before anyone asks: no, the IRS doesn't pay interest if you submit the forms early and they owe you money. I've sometimes wondered whether they're missing a bet there, and if it would be worth rewarding people to file earlier in order to spread out the work a bit better, but until someone sells them on that idea... The purpose is to be a racket. Assuming you're in the same tax bracket, you pay exactly as much tax later as you would now. If you're in a higher bracket, you pay more! And even if you pay less (assuming they don't change tax law before you retire) you give up direct control of your assets in exchange for a promise which may not be honored. The tax year will be determined by the date on the check from Lottery and they will withhold estimated taxes for federal, and for most state, incomes taxes.   Just remember if the ticket is claimed in January, then you will have to wait until the following year to get any possible refund. What you need to do is to reduce the withholding from your wages, or pay a smaller amount in your quarterly payments of estimated tax (if you are self-employed). To reduce withholding from wages, fill out a new W4 form  (available from your employer's HR department). There is a worksheet in the form that will help you figure out what to write on the various lines.  As a single person, you are entitled to claim an exemption for yourself, and if you have not been claiming that exemption, doing so will reduce your withholding, and presumably your tax refund. They are four quarterly estimated tax payments.   The IRS requires that you pay your taxes throughout the year (withholding in a W-2 job).  You'll need to estimate how much taxes you think you might be owing and then pay roughly 1/4 at each of the 4 deadlines. From the IRS: How To Figure Estimated Tax To figure your estimated tax, you must   figure your expected AGI, taxable   income, taxes, deductions, and credits   for the year. When figuring your 2011 estimated tax,   it may be helpful to use your income,   deductions, and credits for 2010 as a   starting point. Use your 2010 federal   tax return as a guide. You can use   Form 1040-ES to figure your estimated   tax. Nonresident aliens use Form   1040-ES (NR) to figure estimated tax. You must make adjustments both for   changes in your own situation and for   recent changes in the tax law. For   2011, there are several changes in the   law. Some of these changes are   discussed under What's New for 2011   beginning on page 2. For information   about these and other changes in the   law, visit the IRS website at IRS.gov. The instructions for Form 1040-ES   include a worksheet to help you figure   your estimated tax. Keep the worksheet   for your records. You may find some value from hiring a CPA to help you setup your estimated tax payments and amounts. She filed for 0 withholdings in her W4, so my (unprofessional) guess   was that she'd be owed money, and therefore the IRS wouldn't care much   if she didn't file her taxes.† Maybe, but doesn't she want that money back? Is she at as much risk as any other individual of being audited and   penalized to the same degree if she skips filing her taxes? Audited and penalized are not the same. She's at the same risk of being audited, and even slightly higher since the IRS got reports of her wages, but didn't get the matching report from her. They may want to ask why. But it doesn't mean she's going to be penalized for anything. Being audited doesn't mean you did something wrong. Or does the IRS tend to overlook such individuals. The IRS might want to overlook because they're the ones owning money. She cannot get a refund without filing a tax return. She'd file her taxes today if she could, but the worry is that time's   running out Filing an extension is free and it postpones the deadline to file till OCTOBER! the government wants to tax your money before you die. If you die your 401(k) becomes part of your estate and will not be taxed to as great an extent.