Calculating & Paying Quarterly Estimated Taxes

Small Business Quarterly Tax Advice

Knowing your tax obligations is essential to running a successful firm. Taxes come in many forms and it can be difficult to keep straight. One form of taxation we would like to focus on is called "Quarterly Estimated Tax." Small business owners are regularly subject to quarterly estimated taxes if their taxes aren’t withheld from wages or other payments. We will explore this concept in depth; discuss who pays Estimated Taxes and how they are calculated. 

What Are Estimated Taxes?

The estimated tax system was intended to guarantee that business owners who have a lot of non-withholding income pay taxes regularly. This creates a balance between business-owner taxpayers and wage earners who pay taxes on each paycheck. Most small business owners meet some or all of their tax obligations through estimated taxes. Estimated taxes are paid on the business’ profits, plus other interest and dividends, capital gains, alimony, rental income, and prizes or awards the business owner may have on a personal level.

Estimated taxes are a ‘pay-as-you-go’ tax. Meaning, four times a year (quarterly), small businesses are required to cover their income tax and self-employment tax (Social Security and Medicare) obligations. This is to be paid on both a federal and state level.

Who Pays Estimated Taxes?

You, personally, must pay estimated tax if both of the following apply: A) If you are self-employed (filing as a sole proprietor, LLC, or  Scorp) and expect to owe $1,000 or more when you file your annual return. In other words, if you did not pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. And B) If you expect your withholding and refundable credits to be less than 90% of the tax shown on your new year tax return or 100% of the tax shown on your previous year's tax return.

If your business is a corporation taxed as a corporation, often referred to as a C corp, the business usually has to make estimated tax payments if it expects to owe $500 or more. 

If you are an employee that receives either salaries or wages, you might be able to dodge paying estimated tax by asking your employer to take more tax out of your paycheck (this is typically done via a W-4). You do not have to pay estimated tax for the current year if you meet all three of the following conditions:

• No tax liability for the prior year
• US citizen or resident for the whole year
• Your prior tax year covered a 12 month period.

Refer to the IRS's depiction on the right to help determine if you have to pay estimated taxes.

Calculating Estimated Taxes

When calculating your estimated taxes, you must determine your expected AGI (adjusted gross income), taxable income, taxes, deductions, and credits for the year. Use form 1040-ES to help you figure your estimated tax. Estimating estimated taxes requires considering all deductions and credits applicable to your situation. This exercise will help reduce the total income at which you will be taxed at, reducing your overall estimated payment. It is also important to note that net capital gains and qualified dividends are taxed at a different rate than regular income. This rate can vary anywhere from 0%-15% depending on the amount subject in this category.

A 3% annual interest rate is used to penalize underpayments; therefore, working through 1040-ES accurately is important. Additional fees may also be attached to underpayment interest penalties. These can accrue for quite some time before you are notified or realize. To avoid this it is beneficial to speak to an accountant and to check each quarter that forms and payment were filed and received.

When Are Payments Due?

Payments should be made on the 15^th day of the month following the quarter. As illustrated below, the months are not a perfect quarter. This schedule is based on the calendar year. However, you are not required to make an estimated payment until you receive income. If your income is subject to take, there is the option to pay based on an installment plan in order to lessen stress on cash flow. The installment option requires that the first payment still be paid on the first payment due date but the amount outstanding can be paid on the remaining due dates.

Estimated Tax Due:	For Income Received:
April 15	Jan. 1 through March 31
June 15	April 1 through May 31
September 15	June 1 through Aug. 31
January 15	Sept. 1 through Dec. 31

If the due date falls on a Saturday, Sunday or legal holiday, you have until the next business day to make the payment. The filing is considered on time if it is postmarked by the due date.

Another option is to pay the entire amount of estimated tax by the first due date. However, if income fluctuates throughout the year, or deductions, credits, etc.; it may be necessary to amend your payments during the year.  If income is volatile it is recommended that estimated payments be calculated and paid each quarter rather than pay in full or estimate based on an annualized amount. This will ensure better accuracy for payments.

Just as you would pay any other taxes due, you can either mail a paper check with your 1040-ES form or you can file electronically using a credit card. If you plan to online, you must first enroll in the Electronic Federal Tax Payment System (EFTPS) which can be done on the www.irs.gov website.

Action Items

1. Review your previous year's tax returns.
2. Figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year.
3. Calculate your estimated earnings for the year.
4. Follow the instructions on form 1040-ES

Additional Reading

1. http://www.irs.gov/publications/p505/ch02.html#en_US_2012_publink10007325 The IRS offers a detailed publication about estimated tax.
2. http://www.bankrate.com/finance/money-guides/paying-quarterly-estimated-taxes-1.aspx A helpful article

For more information, learn about our tax compliance services or book your free consultation today!