As a small business owner, understanding estimated tax payments can save you from unexpected tax bills and penalties. But what are estimated tax payments, and how do they work?
Let’s break it down in simple terms.
What Are Estimated Tax Payments?
Estimated tax payments are taxes you pay throughout the year on income that isn’t subject to withholding. For small business owners, this typically includes earnings from your business, interest, dividends, and other income sources. Unlike employees who have taxes withheld from their paychecks, you’re responsible for paying these taxes on your own.
Why Are They Important?
Paying estimated taxes helps you avoid a big tax bill at the end of the year. The IRS expects you to pay taxes as you earn income, not just when you file your tax return. If you don’t pay enough throughout the year, you could be penalized. By making estimated tax payments, you spread your tax burden, making it more manageable.
Remember, keeping up with your estimated tax payments can make tax season much less stressful.
How to Calculate Estimated Tax Payments
To calculate your estimated tax payments, you must estimate your total income, deductions, and credits for the year. Then, use IRS Form 1040-ES to determine how much you should pay each quarter. If your income is consistent, you can divide your annual tax liability by four and pay that amount every three months.
However, if your income fluctuates, it might be better to calculate your payments based on your income each quarter. This method can prevent you from overpaying or underpaying throughout the year.
When Are Payments Due?
Mark these dates on your calendar to ensure you don’t miss a payment. Estimated tax payments are due four times a year on April 15, June 15, September 15, and January 15 of the following year.
However, you are allowed to adjust your quarterly estimated tax payments based on actual earnings rather than making equal payments each quarter. This is especially useful for businesses with seasonal income.
What If You Don’t Pay Enough?
If you underpay your estimated taxes, you could be penalized when you file your return. The IRS may charge you interest on the amount you should have paid but didn’t. To avoid this, ensure you’re paying enough each quarter—we can help you with that.
What Else You Need to Know
These additional details can help you better understand and manage your estimated tax payments, reducing the risk of penalties and ensuring compliance with tax laws.
- State and Local Estimated Tax Payments: In addition to federal estimated tax payments, business owners may need to make estimated tax payments to their state and local tax authorities. The rules for these payments can vary significantly depending on where your business is located, so it’s essential to be aware of and comply with local tax laws.
- Safe Harbor Rule: The IRS provides a “safe harbor” rule to help avoid penalties. If you pay at least 90% of the tax you owe for the current year or 100% of the tax shown on your prior year’s return (110% if your adjusted gross income was over $150,000), you can avoid penalties, even if you end up owing more when you file your return.
- Record Keeping: Maintaining accurate records of your estimated tax payments is crucial. These records will be needed when you file your annual tax return and can help you track how much you’ve paid versus what you owe.
- Applying Overpayments: If you overpay your taxes in one year, you can apply the overpayment to your estimated taxes for the following year. This can provide a cushion for future tax liabilities.
- Using the IRS Online Payment System: The IRS provides an online payment system, EFTPS (Electronic Federal Tax Payment System), which makes it easy to schedule and make estimated tax payments. This system can help ensure timely payments and accurate record-keeping.
Estimated tax payments are crucial to managing your small business’s finances. By understanding how to calculate and pay these taxes, you can avoid surprises and keep your business running smoothly.
If you’re unsure how much to pay, consider working with us to help you stay on track.