The IRS takes the estimated taxes for small business owners and independent contractors seriously, which makes accurate tax guides crucial for business owners.
In this article:
- Estimated Tax Payments: A Primer
- Who Pays for These Estimated Taxes?
- What Happens If the Taxpayer Did Not Pay the Estimated Taxes?
- When Are Estimated Taxes Due?
- How to Calculate Estimated Taxes
- An Example of Calculating Estimated Taxes for Small Business Owners
- How to Pay Estimated Taxes Properly
Estimated Taxes for Small Business Owners 101
Estimated Tax Payments: A Primer
Employed individuals pay taxes each year, but employers, small businesses, and some freelancers pay taxes quarterly.
However, these quarterly taxes are approximations of income, as the employers, businesses, and freelancers may not know the amount to the last cent. These approximated taxes are what we call estimated taxes.
Employees rarely, if ever, use estimated taxes, as their income is generally straightforward. Some businesses may be of a seasonal nature, and estimating their taxes with a quarter’s earnings may lead to unpredictable spikes of losses and profits.
For example, a gift shop may have losses in the middle of the year, which means they may chalk up their expenses and profits to show a loss and ask for tax credits. However, come holiday season, revenues skyrocket and the business owners will have to rewrite their tax returns.
Estimated taxes can help businesses tremendously with making tax filing easier and at a relatively lower payment plan. At the same time, estimated taxes provide the IRS some revenue while waiting for taxpayers who pay annually.
Tip: Taxpayers who do not withhold income should consider having estimated taxes instead. Not only does this quarterly or monthly plan help taxpayers budget taxes better, but it can also show good faith in case the IRS finds errors.
Also, estimated taxes for small business owners follow the previous year’s taxes, with a few modifications. This system means that people can easily calculate their tax payments provided that they have at least a year’s worth of tax payments under their belt.
Who Pays for These Estimated Taxes?
To qualify for estimated taxes, the taxpayer should have:
- At least $1,000 ($500 for C-corporations) for the current tax year, which is net of all refundable credits as well as any kind of withholding.
- The withholding and credits are less than 2a) 90% of total taxes you currently need to pay for the current tax year or 2b) 100% of the previous tax year’s liability.
The two main groups are 1) the taxpayers with a C-Corporation status, and 2) sole proprietors, LLCs, partnerships, and S corporations.
Most C-corporations have large pockets, which means that they employ their own tax specialist or accountant. Almost all companies in the Stock Market (NYSE and NASDAQ) are C-corporations, since an S corporation has a limit of 100 shareholders.
For group number 1, they must owe at least $500 in taxes so that they can do estimated taxes. For the second group, they must have at least $1,000 in taxes to pay.
A more in-depth monthly guide for estimated and other kinds of taxes can help taxpayers understand the process.
Other taxpayers who need to pay estimated taxes include people who earn at least $600 from dividend income, as well as those with rental assets. People who owe back taxes can also apply for quarterly taxes similar to estimated taxes.
What Happens If the Taxpayer Did Not Pay the Estimated Taxes?
Of course, there are the usual tax penalties to avoid like the failure to pay penalty of .5% and interest. Other penalties can also include a failure to file penalty for underreported income, and possibly negligence or fraud, which are 20% and 75% respectively.
However, for estimated taxes for small business owners, the IRS levies a specific penalty, known as the underreporting penalty. For the tax year 2019, the fee reaches 6% of the underreported income.
When Are Estimated Taxes Due?
Most of the time, the estimated tax payment schedule is quarterly. For most taxpayers, the payment schedules for estimated taxes are:
- April 15th, which is the usual tax deadline;
- June 15th;
- September 15th, and;
- January 15th.
If the 15th happens to fall on a weekend or a business holiday, the deadline moves to the next business day.
For most corporations, the payment schedule falls on every start of the fiscal quarter for a corporation, except for the first quarter, specifically every 4th, 6th, 9th, and 12th. Every corporation has its own fiscal year, so the payment schedule is on a case-by-case basis.
However, the IRS does allow a monthly payment plan. The taxpayer can also elect to have their payment plan changed to quarterly from monthly, and vice versa, if they want to plan their budget accordingly.
Once the IRS sets up the information of a small business in their database, they usually send the estimated taxes payment vouchers after every tax year. However, even if the taxpayer did not receive the payment vouchers, they still have to pay the estimated taxes on time and may want to contact the IRS for further assistance.
How to Calculate Estimated Taxes
Taxpayers can look for Form 1040-ES to prepare filing for estimated taxes.
- The previous tax return, specifically to get the previous tax amounts.
- Form 1040-ES, for taxpayers to easily find out the tax rate schedules, plus the estimated tax worksheet for deductibles and taxable income.
- IRS Publication 505 for a document ready to answer any difficult questions that cannot be found in Form 1040-ES.
An easy way to calculate estimated taxes is to take the previous year’s tax amount and divide it into four (for quarterly) or 12 (for monthly) payments. However, the taxpayer should always update the deductibles as well as income sources.
Taxpayers can do more thorough accounting by filling out the quarterly tax payment vouchers. Using Form 1040-ES, taxpayers start by:
- Answering page 8 and 9 of the form, where the taxpayer fills out the information for a general estimate, deductibles, and credits.
- Proceed to Page 11, for a basic summary of what the taxpayer owes for estimated taxes.
For estimated taxes, the IRS does not require that every cent is properly accounted for. The IRS does not have the manpower to go through every detail on how a taxpayer reached the estimated tax, as most of the primary review goes through the automated IRS system.
However, paying taxes accurately is highly recommended, as paying too little can trigger an audit, and paying too much wastes money.
For self-employed taxpayers, do not forget to also pay for FICA (Social Security and Medicare) for both the employee and employer contributions. The total contributions should reach 15.3% of income, with 12.4% for Social Security and then the rest, 2.9%, for Medicare.
An Example of Calculating Estimated Taxes for Small Business Owners
Let us say for the first quarter, an independent contractor has only one source of income and earned $50,000 and used $15,000 for business expenses.
The taxpayer has a net profit of $35,000 for the first three months, and since the work is not seasonal, the taxpayer can project that for the year, he or she can earn an estimated $140,000. $35,000 multiplied by four (corresponding to the quarters of the year) is $140,000.
- FICA or self-employment tax is 15.3%, which means that the taxpayer should submit $21,420. $140,000 multiplied by 15.3% is $21,420.
- Standard deduction for a single taxpayer is at $12,200 as per Forbes 2019 Tax Rates.
- For 2019, the Tax Cuts and Jobs Act has set the personal exemption taxes to 0. Some taxpayers are accustomed to filling out a personal exemption tax, so this announcement needs emphasis to prevent inaccuracies.
- Total taxable income is $140,000 minus $33,620 ($21,420 and $12,200 for FICA and standard deduction), which means that the taxable amount is $106,380.
- Therefore, the tax due for the whole year is $19,753.70. The amount comes from $106,380 minus $14,382.50 and $5,371.20 (24% of $22,380 the amount over $84,000).
- The taxpayer can then pay a quarterly tax of $4,938.43.
How to Pay Estimated Taxes Properly
Taxpayers can elect the following:
- Mailing Form 1040-ES payment vouchers with the check. Tip: Make it payable to the United States Treasury, as some criminals can change IRS to a different name.
- Use the IRS Direct Pay system. Do note that the Direct Pay method assists personal taxes only, so corporations may look for other alternatives.
- Pay via credit or debit card with the IRS authorized partners. This payment method is faster, but the providers may charge payment processing fees.
- Use the Electronic Federal Tax Payment System of the United States Department of Treasury.
Estimated taxes for small business owners can help both the IRS and the taxpayer with their tax payments, as long as the taxpayer abides by the procedures properly.
Do you pay estimated taxes? Do you find it best to pay annually, quarterly, or monthly? How do you find the IRS’s estimated tax process? Please give us your thoughts in the comments section below.
If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.