Please note: Live Oak Bank does not provide tax advice. Please consult with your accountant.
If you are new to running your own business, you might not have encountered the need to pay federal estimated quarterly taxes—especially if you have only worked for an employer that withheld taxes for you in the past. The IRS requires that taxes be paid as income is earned. There are two ways taxes are paid—either through withholding or through estimated quarterly tax payments.
Large employers withhold taxes for employees based on their income and information on their W-4 forms. For individuals and small businesses, tax is not automatically withheld from your earnings. If income is earned and taxes are not withheld, taxes must be paid quarterly by the individual or small business to avoid interest and possible penalties.
Who pays?
Individuals, including sole proprietors, partners, and S corporation shareholders, typically have to pay estimated taxes if they expect to owe tax of $1,000 or more when their returns are filed. Corporations are typically required to pay estimated taxes if they expect to owe tax of $500 or more when their returns are filed. Estimated tax payments cover income tax, as well as other taxes including self-employment tax and alternative minimum tax.
How to calculate
The IRS Publication 505 details all the information regarding estimated taxes—who needs to pay, how to estimate what you owe, and how to pay.
You will need to file the IRS Form 1040-ES, which is used to determine your estimated tax liability. That amount is determined by your income, credits, expenses, and deductions, as well as previously paid taxes.
If you know that your income is steady throughout the year, you can estimate how much you owe for the year, divide that by four, and pay that amount quarterly.
If your income varies, you will want to estimate your taxes at the end of each quarter. You will need to determine your annualized income—an estimate of your business’s annual income. You can do this based on what you’ve earned and spent so far that year along with what you expect to earn in the coming quarters. In the Publication 505 on the IRS site, you will find a worksheet to help you determine what your annualized estimated tax will be.
If you underestimate or overestimate your income, you can fill out an additional Form 1040-ES and submit that with your next quarter’s estimated taxes. If you underestimated the amount you owe, you can pay the additional tax with that next quarter’s payment. This will also need to be addressed with an additional form when you file your annual tax return. If you overpay your estimated taxes, you can ask for a refund or apply that amount to your future estimated tax payments.
Depending on how complex your business activities might be and your accounting abilities, you might want to consider using some good accounting software or even hiring an accountant. This will not only help you save money but will lessen your chances of making errors, thereby reducing your liability risk.
How to pay
Once you’ve determined the amount you owe each quarter, you will need to submit your payment with Form 1040-ES. You can mail your form and payment, pay online, or use the IRS2Go app. Visit IRS.gov/payments for more information.
Be sure to pay attention to the dates the payments are due. Rather than the one tax date you’re used to remembering, you will now need to remember four dates, anticipating those well in advance to stay on time and remain compliant.
Estimated tax payments due dates are:
- For income earned January 1 to March 31, taxes are due April 15
- For income earned April 1 to May 31, taxes are due June 15
- For income earned June 1 to August 31, taxes are due September 15
- For income earned September 1 to December 31, taxes are due January 15 (of the following year)
If these due dates fall on a Saturday, Sunday, or federal holiday, the payments are due the next business day.
You can also make more frequent payments if you prefer to spread out the tax burden. For example, you might want to consider making monthly payments.
Don’t forget your state taxes
You might also need to pay quarterly estimated taxes in the states where you conduct business. These taxes might include state and local income taxes, sales and use taxes, and employment taxes. If you conduct business in more than one state, you might need to pay estimated taxes in multiple states. Consider where you conduct business, where you store inventory, and where your employees are located when reviewing state guidelines for estimated taxes.
Putting in the time to properly estimate and pay your tax liability will save you money in the long run. The IRS imposes interest and/or penalties if you don’t pay the proper amount of taxes throughout the year and if your payments are late. The IRS could charge penalties even if you are due for a refund, and those penalties can amount to several hundred dollars. So, make sure you are doing everything you can to stay compliant and timely with your quarterly estimated taxes.
