One of the
biggest mistakes small business owners make during the start-up phase is misunderstanding their tax
obligations. And it’s easy to make these mistakes, especially if you have gotten used to working
for an employer who took care of the bulk of your income tax withholding and Social Security and
Medicare deductions.
So just exactly 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?
Uncle Sam requires
that individuals and businesses pay taxes almost as quickly as they earn income. This means you have
to pay taxes over the course of the year instead of waiting until April 15. If your taxes are not
withheld by an employer then you will likely need to pay estimated tax payments each quarter.
Estimated
tax payments include both your income tax obligations as well as your self-employment tax (Social
Security and Medicare) obligations – which, by the way, will increase the total federal taxes you
owe.
Who Pays Estimated Taxes?
Generally, if you carry on a trade or business as
a sole proprietor, an independent contractor, a member of a partnership, or are otherwise in
business for yourself, then you are considered a self-employed individual. According to the IRS, If
your tax withholdings don’t cover 90% of your tax liability then you must pay estimated taxes on
income that is not withheld (use Form 1040-ES).
If you operate a corporation, you generally
have to make estimated tax payments if you expect to owe tax of $500 or more when you file (use Form
1120-W).
You don't have to make federal estimated tax payments if your tax due, after taking
withholdings into account, is less than $1,000 or if your withholding and credits add up to at least
as much as your prior year’s tax.
How Much Should You Pay in Estimated Taxes?
The
IRS recommends that you calculate your quarterly estimated tax payment using Form 1040-ES (the same
form used to pay estimated taxes) which comes with a worksheet that helps you estimate how much you
owe for the current year. Corporations can use Form 1120-W to calculate estimated taxes.
You
are not obligated to use this calculation method and can instead refer to the estimated tax
calculation on your previous year’s tax return (most online tax tools will calculate this figure
for you when you complete your return).
If you are an independent contractor, and face
fluctuating periods of income, you might prefer to calculate your estimated taxes on a quarterly
basis based on the income and deductions for the quarter owed.
If you still feel that you are
essentially guessing what your estimated payment should be, take a look at this guide* from
Fairmark.com which includes pointers on how to best calculate your estimated payments.
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 endeavor 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 actually an easy process and the best thing
is that you don’t have to explain to the IRS how you reached your estimated sum (any
reconciliation is done during tax return season). If you are filing as a self-employed individual
you should use Form 1040-ES which includes quarterly payment vouchers to submit with your payment.
Corporations can deposit the payments by using EFTPS 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 that
you don’t have to worry about downloading the latest forms.
What about Estimated State
Income Taxes?
You need to pay your estimated state income taxes at the same time as you
pay your federal taxes. Find links to your state's tax office for the appropriate forms here.
Contact
a Member Firm
At the end of the day, it’s worth spending an hour with a tax specialist
to help you understand what the best calculation methods are, how to appropriately track and deduct
expenses, and maintain good records. If you need a tax specialist, please contact
one of our member firms.
This work has been modified. The original is
available here.
This work has been reproduced under a Creative
Commons 3.0 license.
