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How To Calculate and Make Estimated Tax Payments
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How To Calculate and Make Estimated Tax Payments
As a new business owner, understanding your tax obligations is critical and one of the first requirements you’ll need to understand are estimated tax payments.
What are estimated taxes? Who must pay them and how? Below are some facts from the IRS Estimated Tax Guide to help new small business owners understand their estimated tax obligations.
What Are Estimated Taxes?
The IRS and your state’s treasury department require that individuals and businesses pay taxes almost as quickly as they earn income. If taxes aren’t withheld from wages or other payments, then you will likely need to pay estimated tax payments each quarter.
Think of estimated taxes as a “pay-as-you-go” tax. Four times a year (quarterly), you are required to send Uncle Sam enough of your revenues to cover your income tax and your self-employment tax (Social Security and Medicare) obligations.
If you don’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. However, the IRS knows that calculating earnings isn’t easy, so it offers a safe harbor rule – if you pay at least as much as your previous year’s liability or pay within 90 percent of your actual liability, there’s no penalty for underpayment.
Who Pays Estimated Taxes?
If you are self-employed and expect to owe $1,000 or more when you file your annual return, then you must pay estimated taxes on income. If it’s not through withholding, then it has to be done by quarterly estimated taxes. If your business is structured as a corporation, you’ll need to pay estimated taxes if you expect to owe $500 when you file.
How Much Should You Pay in Estimated Taxes?
Calculating what you owe each quarter requires figuring out your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. Each business situation is different, especially if you are a new business owner, so it’s worth spending some time with a tax advisor to understand the best calculation method for your situation.
You have a number of options when it comes to calculating what you owe each quarter:
- Use Form 1040-ES – You can calculate your quarterly estimated tax payment using Form 1040-ES (the same form used to pay estimated taxes), which includes a worksheet that helps you estimate how much you owe for the current year. Corporations should use Form 1120-W to calculate estimated taxes.
- Refer to Last Year’s Return – If you have been in business for a while, you can refer to your previous year's federal tax return. Include all the income and deductions you expect to take on your current year's tax return and refer to the total tax you paid so that your estimated tax payments are in the same range as last year’s taxes (100-110 percent is the range to shoot for to avoid underpayment problems).
- Make a Quarterly Calculation – If you are a freelancer or independent contractor and face fluctuating or cyclical income, you might prefer to calculate your estimated taxes on a quarterly basis.
The IRS offers more advice in its Estimated Taxes Guide on how to calculate your payment and adjust estimates if you think you are paying too much – or too little – as the year progresses.
When Are Payments Due?
For estimated tax purposes, the year is divided into four payment periods. Payments for each year are due on the 15th day of April, June, September and the following January. You should try to pay at least the minimum owed by the due date (with the remainder paid on April 15), or risk incurring penalties from the IRS or your state.
How To Pay Estimated Taxes
Paying your estimated taxes is an easy process. If you are filing as a self-employed individual, use Form 1040-ES, which includes quarterly payment vouchers to submit with your payment. Corporations can deposit the payments by using the Electronic Federal Tax Payment System for deposit coupons (Forms 8109). Once you are in the system, the IRS will send you payment vouchers at the end of each tax year so you won't have to worry about downloading the latest forms.
Paying Estimate Taxes to Your State?
You need to pay your estimated state income taxes at the same time you pay your federal taxes. Find links to your state's tax office for the appropriate forms here.
Talk to a Tax Specialist
Spend an hour with a tax specialist to help you understand what the best calculation methods are, how to appropriately track and deduct expenses, and how to maintain good records. Many will provide this initial consultation for free simply because they hope you will return and use them come filing season.
- SBA.gov Small Business Tax Guide
- Startup Cost Tax Deductions – How to Write Off the Expense of Starting Your Business
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