One of the biggest surprises for a small business owner is how much your taxes change. When you’re working for someone else, you pretty much only think about taxes once per year, when they’re due. But once you start your own business, taxes get a lot more complicated. Suddenly you have bookkeeping to do, self-employment taxes to pay, and estimated tax payments to make.
While estimated tax payments can be confusing and complicated at first, once you understand them it becomes an easy item on your business taxes to-do list. To get you started on the right path, here’s what you need to know about estimated taxes.
Who Needs to Pay Estimated Taxes?
The U.S. tax system is a pay-as-you-go system, meaning you don’t wait until the end of the year to cut one big check to the IRS. You make payments throughout the year as you owe taxes.
If you’re employed by a company and receive a W-2, the pay-as-you-go system is simple—your company withholds taxes from each paycheck for you and sends that money to the IRS. They make it easy on you by paying your taxes throughout the year (based on the withholdings you designated on your W-4), and then you settle the difference once a year at tax time.
But if you’re self-employed, or you don’t have enough tax withheld, it’s your responsibility to make estimated tax payments to the IRS at least quarterly.
Typically, sole proprietors, partners, and S-corp shareholders need to make estimated tax payments if they are going to owe more than $1,000 in tax at the end of the year.
Even if you’re not self-employed, there could still be other reasons that you have to make estimated tax payments. If you receive income from additional sources and don’t have enough taxes withheld, you’ll need to make estimated tax payments. This includes income from:
- Capital gains
- Prizes and awards
Estimated tax payments can be used to cover a number of different tax liabilities: income tax, self-employment tax, and alternative minimum tax.
How to Avoid Making Estimated Tax Payments
If you receive a salary from an employer that withholds taxes, there’s a way to avoid having to make estimated tax payments on your additional income: Ask your employer to increase how much they withhold from your paycheck each tax period to cover your tax liability from other income sources.
For example, if you work full time for a company but you also do some freelancing work on the side, you can ask your full-time employer to increase how much they take from your paycheck each pay period. Sure, your paycheck amount will decrease because you’re having more withdrawn for taxes, but you won’t have to file estimated tax payments each quarter.
To have your employer withhold more from each paycheck, you’ll need to file a new W-4 to have the amount that is withheld increase.
If you’re not sure how much should be withheld from your paychecks, you can use the paycheck check-up tool from the IRS to make sure you’re having enough withheld during the year.
When Are Estimated Taxes Due?
Estimated tax payments are due four times per year. If the due date falls on a Saturday, Sunday, or holiday, the payment due date is the next working day. For example, if April 15 falls on a Saturday, the payment will be due on Monday, April 17.
|For the period||Due date|
January 1-March 31
April 1-May 31
June 1-August 31
September 1-December 31
January 15 (following year)
That last estimated tax payment gets made in the following year. But you can skip that fourth payment if you file your tax return for the previous year by January 31. For example, if you file your tax return for 2019 by January 31, you don’t have to make the estimated tax payment that is due on January 15.
How Much Do You Have to Pay in Estimated Taxes?
This part can get tricky. The IRS provides Form 1040 ES, Estimated Tax for Individuals, to help you calculate how much you should pay in estimated taxes, but it is a complicated form.
If this isn’t your first year making estimated tax payments, you’ll have an easier time figuring out how much to pay. If you’ll likely make the same amount this year as you did during the previous year, you’ll take the total amount of tax that you paid and divide it by four to give you your quarterly estimated tax payment amounts.
But if you haven’t done this before? You’ll use form 1040 ES to walk you through a calculation. You’ll need to have an estimate of your adjusted gross income for the year and your deductions to calculate your estimated tax liability for the year.
When going through the calculation, don’t be surprised if you owe more than you expect. If you’re self-employed, you’ll be paying both your income tax and your self-employment taxes. Self-employment taxes are 15.3%, which includes 12.4% for social security taxes and 2.9% for Medicare.
You can find calculation instructions on Form 1040 ES.
If you’re struggling to figure out how much you will owe in estimated taxes, consider working with an accountant. They can ensure you’re paying the correct amount by the correct date so you avoid penalties.
How Do You Make Estimated Tax Payments?
Once you know how much you have to pay, you can make your estimated tax payments online, by phone, or by mail.
- Paying online: The IRS makes it easy to make payments online through https://www.irs.gov/payments. You can make payments for free using your bank account. Or if you prefer to pay by debit or credit card, you can, but you’ll be charged a fee.
- Paying by mail: If you prefer to mail your estimated tax payment, you’ll find vouchers for each quarter included with Form 1040 ES. Use one voucher for each payment and fill in the relevant information before mailing it in. Keep in mind, though, the IRS does suggest that paying online or by phone is a more secure and reliable option, so consider using that to make your payments.
What Happens If You Don’t Pay Estimated Taxes?
The IRS doesn’t like to get their money late, so if you miss an estimated tax payment or you underpay what you owe, they may charge you a penalty. In 2015, 10 million people were required to pay a tax underpayment penalty.
And bad news for anyone who skips a quarterly payment: If you miss an estimated tax payment deadline, you will still be hit with a penalty even if you are due a refund when you file your taxes.
To calculate your penalty, you’ll fill out Form 2210.
How Can You Avoid the Penalty?
If you underpay your estimated tax, all hope isn’t lost. The IRS knows that you’re not always going to get the calculation right, so they do give you a little wiggle room for avoiding the penalty. The IRS states that you can generally avoid paying an underpayment penalty if:
- You owe less than $1,000 in taxes after subtracting any withholdings and credits.
- You paid at least 90% of your tax for the current year or 100% of your tax from last year, whichever amount is smaller.
- You missed payments because of a casualty, disaster, or some other circumstance that would make imposing the penalty unfair.
- You retired or became disabled during the tax year.
The IRS isn’t unreasonable—if you tried to get the calculation right (and came close) or there was a situation that kept you from making payments, they will likely waive the penalty.
The Bottom Line
Making estimated tax payments can be confusing for new business owners, but once you have your system set up and know how much you will likely owe in taxes, making these payments gets much easier.
If you haven’t done so already, we recommend working with an accountant or another tax professional familiar with your type of business who can help make the process easier.