Who should pay estimated quarterly taxes? And, if you are responsible for paying estimated quarterly taxes, how much should you pay, and how should you make the payments?
In today's episode, I will break down everything you know about paying estimated quarterly taxes as a business owner. Stay tuned.
Directly from the IRS, taxes must be paid by everyone that earns or receive Income throughout the year. Taxes can either be paid to the IRS via withholdings or estimated tax payments.
If you are a business owner, there is a 90% chance that you must make estimated tax payments. You may be charged a penalty if you don't pay enough tax through withholdings and estimated tax payments. You also may be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.
Let's deep dive into everything you need to know regarding estimated quarterly tax payments for business owners.
Who Should Pay Estimated Quarterly Taxes?
Anyone who is a freelancer, self-employed, or a business owner generating profit within their business has to pay estimated taxes.
If you do not have taxes withheld on your paychecks, you should be paying estimated taxes.
If you are a business owner who expects to owe $1,000 or more in taxes, you should pay quarterly taxes.
If you receive a salary, it is still possible to pay estimated taxes depending on your projected tax liability.
If taxes are withheld from your paycheck, in most cases, you will not have to pay estimated quarterly taxes.
What Is Needed To Calculate Your Estimated Quarterly Taxes
There are five things you need to know to calculate estimated taxes:
- Your expected adjusted gross Income - as known as AGI
- Your Taxable Income
- Credits for the year
When determining the items I just mentioned, a good reference will be to use information from the previous year's tax return or financials.
Also, you can use a Form 1040-ES worksheet to calculate your taxes.
To complete the form, you must first determine your adjusted gross income for the year.
To determine your Adjusted Gross Income, calculate your Income from Wages, Investments, Business Income, and any other income you expect to receive in the tax year.
Once you have identified your AGI, you need to project your total deductions and taxable Income for the tax year.
Let's break this down:
Your taxable Income is the amount of Income subject to taxes.
A tax deduction (or tax write-off) is an expense that can be deducted from your Taxable Income. More about tax write-offs in a moment.
For businesses (as you see on the screen), if you take your Revenue-Expenses (a.k.a deductions), that will give you your Taxable Income amount.
A tax deduction allows you to lower your taxable income, and as a result, you pay less taxes.
Now, let's discuss tax deductions:
There are two types of deductions for business owners. You have COGS and Expenses.
Both deduction types can reduce your taxable Income.
Examples of COGS – if you sell books, t-shirts, and website hosting.
Examples of expenses include advertising, bank fees, interest, legal and accounting fees, insurance, office supplies, property taxes, rent, and utilities.
How To Determine Your Estimated Tax Payment
Once you have your Taxable Income, you will use the IRS Tax Rate Schedule to estimate your yearly taxes.
The IRS Tax Rate schedule shows the income tax percentages and tax brackets for each income level. It will also help you determine your tax liability for the year.
Once you have this information, you must also include a self-employment tax rate of 15.3% on the first $147,000 of earned net Income, if you are a sole proprietor or partnership owner.
The Net Income for your business is when you take your total yearly Business Revenue and subtract your expenses.
The total would be either a Net Income (aka Net Profit) IF you earned more revenue than you spent for the year. Or a Net Loss - meaning you spent more money than you earned for that year.
Now let's bring it all together to determine your estimated quarterly tax payments.
- Calculate your Adjusted Gross Income
- Identify your deductions
- Use the IRS tax rate schedule to compute your federal income tax
- Then add in your self-employment taxes.
- The total will equal your estimated tax liability for the year.
- Once you have that number, divide it by four, and that will give you your quarterly estimated taxes.
Keep in mind that the IRS is aware that this is an estimate. Therefore your number may not be 100% accurate.
How To Pay Estimated Tax Payments
You can pay your estimated tax payments online at IRS.gov/payments, by phone, with a check or money order.
If you pay by check or money order, make sure it is paid to the United States Treasury and that you mail it to the correct address. You can find all of this information at the IRS.gov/payment website.
How To Avoid The Estimated Tax Underpayment
To avoid the estimated tax underpayment penalty, you should pay at least ten percent more than your previous year's tax liability to the IRS.
In the eyes of the IRS, when you do this, you demonstrate a responsible taxpayer, and you are seen as operating in good faith.
For additional tax tips, download our Tax Form Checklist below.