If you own a business, you need to understand how to fulfill your tax obligations. Quarterly estimated taxes aren’t optional. As such, incorrectly handling these payments won’t just land you in hot water with the taxman – it could also affect your bottom line, through fees and penalties. And that can disrupt your business’ cash flow and budgeting.
In this article, we’ll guide you through everything you need to know about estimated taxes, to help you maximize your benefits and avoid penalties and non-compliance.
Understanding Estimated Taxes
So what exactly are estimated taxes? In a nutshell, they’re used to pay taxes on all income that is not subject to withholding. This includes self-employment income, interest, rent, alimony, and dividends. As a business owner, you’re expected to calculate and submit quarterly estimated taxes to the IRS, on the following dates:
- April 15th
- June 17th
- September 16th
- January 15th
However, if these deadlines fall on a weekend or legal holiday (i.e. Martin Luther King, Jr. Day in January, and Washington D.C.’s Emancipation Day in April), you have until the following business day to submit your payment.
Who needs to pay?
Sole proprietors, partners, and S Corp shareholders who owe more than $1,000 in taxes are all expected to pay estimated taxes. Corporations also need to make estimated payments if they expect to owe $500 or more when filing their returns.
Why estimated taxes are necessary
Paying your estimated tax payments helps you manage your tax obligations and avoid penalties. But it’s also beneficial to your business operations, by helping you manage your cash flow. This ensures that you’ll have a real-time picture of your company’s financial health, which goes a long way in accurate financial planning.
Of course, there are benefits and drawbacks to paying estimated taxes. On the one hand, regular payments help you stay in good standing with the IRS. They also mean smaller, more manageable tax bills spread out throughout the year, to help you keep a closer eye on your finances.
However, they require you to track four different deadlines and work on your taxes throughout the year. In addition, there can be penalties associated with underpaying. That’s why it’s vital to ensure that you calculate your estimated taxes correctly.
How to Calculate What You Owe
How much you pay each quarter depends on your business income. Your calculations will depend on your expected adjusted gross income, taxable income, taxes, deductions, and credits for the entire tax year, based on current tax rates.
There are three main ways to calculate what you owe.
- Annualized income method. This involves estimating your current quarterly income based on actual earnings to date. You would need to factor in seasonality or irregular income patterns, especially if your income fluctuates throughout the year.
- Percentage of income method. With this approach, you estimate your quarterly tax payments by applying a predetermined percentage to your projected annual income. This is typically based on your effective tax rate. For instance, if your effective tax rate is 20%, you would multiply your projected annual income by 0.20 to determine your quarterly tax payments.
- Prior year safe harbor method. For those whose income remains relatively consistent year-over-year, this method involves basing quarterly tax payments on the previous year’s tax liability.
If your estimate was too high or too low, you can complete Form 1040-ES to recalculate your estimated tax for the next quarterly deadline.
How to pay your estimated taxes
The IRS accepts estimated tax payments online, or via the IRS2Go app. You can also pay directly from your bank account using the IRS Electronic Federal Tax Payment System (EFTPS). Alternatively, you can mail your payments to the IRS.
Remember that estimated taxes can be paid once-off or in installments, as long as the total amount is paid by the deadline at the end of the quarter.
Consequences of Underpayment
Underpayment on your quarterly submissions can lead to penalties that accrue based on the amount of tax owed and how long you have been underpaying. Moreover, these penalties are subject to interest that builds daily.
Even if your business can’t pay in full, try to pay as much as possible. Then, you can apply for a payment plan to reduce future penalties.
How penalties are calculated
Sometimes, it’s possible to avoid a penalty. This usually happens if your business owes less than $1,000 in tax after subtracting your withholdings and credits, if you have already paid at least 90% of your taxes for the current year, or if your business has fully paid all taxes for the previous year.
If your business receives irregular income, it’s also possible to annualize your income and pay estimated taxes based on that amount, to avoid or lower penalties. If you choose to do this, you’ll need to complete Form 2220 (Underpayment of Estimated Tax by Corporations).
Remember that penalties might apply at federal and state levels, especially if you run a C Corp.
Tips for Managing Estimated Taxes
The first step to keeping on top of your estimated tax payments is efficient record-keeping. This includes accurate income and expense management. After all, you’ll need to provide proof of any revenue you report going into or out of your business. Also, the IRS recommends keeping your records for up to three years, so having everything stored safely and securely is essential.
Your accounting software plays a huge role here. Platforms like QuickBooks or NetSuite will help you keep track of all income and expenses, and ensure that your financial reports are in order. As a bonus, they can be integrated with a range of other software options, in case you need to track expenses that might be used to apply for credits or deductions, from employee timesheets, to travel and mileage.
The next step is efficient budgeting, and incorporating your estimated payments into your accounting practices. By regularly putting aside money towards your quarterly estimated taxes, you can lower the risk of penalties, and the hefty interest rates that come with them. This is particularly relevant if your business experiences income fluctuations.
It’s also worth looking into investments that can reduce your tax liability. For example, employer-based retirement plans such as 401(k)s or health savings accounts can lower your taxable income.
Work with a tax professional
A tax expert can help you with more than just calculating and paying your estimated taxes. Tax laws are always changing, and not knowing about these changes could mean that you lose out on potential savings. Moreover, a tax pro can help you stay on top of deadlines and ensure your paperwork is in order. Most importantly, they can help your business create a tax strategy that will save you as much money as possible in the future.
Fusion CPA can help. Our tax subscription service lets you partner with knowledgeable CPAs to do your taxes while you focus on your core business. When we handle your taxes, we don’t just want to make the process stress-free. We also want to save you money; and that starts with a tailored tax strategy to help you save in the long run.
If you’re ready to take your tax planning to the next level and eliminate the stress of quarterly estimated payments, schedule a Discovery Call with one of our CPAs.
The information presented in this blog article is provided for informational purposes only. The information does not constitute legal, accounting, tax advice, or other professional services. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information contained herein. Use the information at your own risk. We disclaim all liability for any actions taken or not taken based on the contents of this blog. The use or interpretation of this information is solely at your discretion. For full guidance, consult with qualified professionals in the relevant fields.
