Let’s face it: figuring out quarterly estimated tax payments are the biggest headache for new business owners. Do you have to pay estimated taxes? How much? When?
First, it is important to understand the difference between being an employee vs being an owner/contractor/freelancer:
- Taxes are paid first from your income (Payroll, federal, state, and city)
- You get the remaining amount in your paycheck
- Business Owner-
- You receive payments that get deposited to a business checking account
- Over the course of a year, you use some of this money for business expenses and
- You transfer some of this money to your personal account to pay yourself
- Each quarter, you should be paying estimated taxes to the IRS and state
For most business owners, when you get to step 4, your bank account doesn’t have any money to pay taxes, and you go back to step 1.
As you can see, when you are an employee, you do not have any choice to pay taxes, it is done for you, automatically, and even before you can receive a paycheck. For a business owner, taxes are paid at the end, and often times estimated taxes are not paid at all.
Here are some simple guidelines to figure out your estimated tax payments:
Do I need to pay estimated taxes?
If your tax liability is $1,000 or more, then you are required to pay estimated taxes. If it is less than $1,000, estimated payments are not necessary.
The best way to determine your tax liability is to keep good bookkeeping records throughout the year, hire a bookkeeper, and/or consult with your tax preparer.
How much do I pay?
In order to avoid penalties on your tax return, you must pay in enough taxes during the year to meet one of the two IRS “safe harbor” rules:
1. Pay 100% of last years tax liability (110% if you made over $150k)– To accomplish this, simply take last years tax return, look at line 61 of form 1040, and divide that number by four. For example, if line 61 of last years 1040 showed your total tax liability of $10,000, to meet the safe harbor requirement you would need to make four estimated payments of $2,500.
2. Pay 90% of the current year’s tax liability- This rule is tricky because it requires you to know very early on exactly how much money you will owe in taxes at the end of the year.
When do I pay estimated taxes?
Quarterly estimated tax payments are due:
- April 15
- June 15
- September 15
- January 15
What if it’s April 20 and you missed the first payment? It’s better to pay it as soon as you can even if it’s late rather than to wait until the following year to pay what you owe.