In addition to the numerous other hurdles facing new business owners, entrepreneurs and freelancers have an array of tax requirements with which to contend. Not the least of which includes making estimated tax payments throughout the year. While many are aware that they need to pay estimated taxes, these calculations prove themselves to be more complicated in practice. Many find it difficult to budget properly for these costs, leaving them with steep tax bills they can't afford to pay. For some business owners, the tax debt that results from overdue tax payments, interest, and penalties can even threaten your business's ability to grow and thrive. However, it is possible to sidestep these issues by putting the right tax processes in place.
What Are Estimated Tax Payments?
The basic concept of estimated tax payments is this: at the end of the year, every individual and business must have paid a certain amount of tax that corresponds with their earnings. In actuality, these tax payments are made throughout the year based on what each individual and business expects that they will earn during the 12 months.
When working for an employer, most individuals will have a certain percentage of their income withheld so that their employer can make these payments on their behalf. The employer then reports the payments that were made via Form W-2.
Small business owners, on the other hand, are responsible for estimating and making their own tax payments throughout the year. Typically, these estimated tax payments are due on January 15, April 15, June 15, and September 15 of each year.
This requirement applies to individuals receiving 1099s, sole proprietors, S corporation shareholders, owners of LLCs that are treated as disregarded entities or taxed as partnerships, and anyone else who meets the filing requirements and has not had taxes withheld.
Where Do Small Businesses Go Wrong?
It would be easy to think that most small businesses get into trouble simply because they fail to pay their estimated taxes. As it turns out, the reality is more complex. It's far more common for entrepreneurs to make a mistake, pay the wrong amount, or miss a deadline. Business owners assume they've done what's required, only to find out months later that they've made a costly mistake.
Many do not realize that estimated tax payments include the amounts for federal income tax (which range from 10 to 37 percent), state and municipal tax (ranging from 0 to 13.3 percent), and self-employment tax--if applicable. Failing to account for all of these tax payments may leave some business owners without the budget necessary to cover the full cost.
To make matters worse, the IRS and state tax authorities charge penalties and interest for late estimated tax payments. Often, business owners do not become aware of overdue payments until after their year-end tax return has been filed. This leaves entrepreneurs with a large and unexpected tax bill.
How to avoid Issues with Estimated Tax Payments
There are a few options for how to handle your quarterly tax payment calculations:
- If you have a good idea of how much you'll earn throughout the year, you can estimate the full amount you'll owe for the year and then send one-quarter of that amount to the IRS.
- Alternatively, you can estimate your tax bill for the year based on what you've earned so far. Use these figures to forecast your earnings and deductions for the year.
- If you're married and your spouse works for an employer who withholds taxes from their paychecks, you may be able to avoid paying estimated taxes altogether. You can update your spouse's Form W-4 to withhold the amount for your earnings as well as theirs.
While the IRS provides documentation and worksheets to help with these calculations, navigating these rules on your own gets complicated quickly--making it more likely that mistakes will happen and business owners will become overwhelmed. The easiest way to avoid falling into the estimated tax trap is to work with an accountant either at the time you start your business or as soon as you realize you'll need to make payments. Doing so will help ensure that you never pay more than you have to--and save you the stress and frustration of going it alone.