Estimated tax payments for the small business owner: Who, What, When, Where…
Here are the 5 W’s, some H’s, and some pro tips related to estimated tax payments and penalties.
Why do I have to pay estimated taxes?
While you were swimming blissfully in predictable cash earnings and forty-hour work weeks (i.e. an employee for someone else’s company) most if not all of the income tax you were expected to owe for your wages was being withheld and paid to the Fed and State on your behalf (on time). Now that you are working twice as hard for half the pay and wearing too many hats already, Uncle Sam is making you responsible for paying these estimated taxes on your business earnings (quarterly) because he does not want to wait until April 15th to collect.
Who pays the tax?
Whether you are self-employed, a managing partner in a partnership, or an employee of your own corporation, if your business is making a profit (i.e not losing money) then there is a high likelihood that you should be making estimated tax payments on either self-employment income, ordinary income, or both.
PRO TIP - If you have a profit on your business then you might owe self-employment tax even if your taxable income is zero on your 1040.
To reach the largest audience and keep things simple, this article will focus on Single Member LLC owner / members and sole proprietors.
The tax from a single member LLC or a sole proprietorship (or any ‘flow-through’ entity) is assessed on a personal/individual level. This means that you as an active LLC member, business owner, or participating partner are responsible to make payments for your share of the company profit.
What is taxed? The profit that your business ‘flows through’ to you for any given tax period is subject to ordinary income tax and most often self-employment tax.
PRO TIP - Because you do not get a deduction for what you pay yourself, your tax will stay the same if you leave the cash in the business bank account or take it out to pay yourself with it.
To be noted, If you are a partner in a partnership or a shareholder in a corporation, there are differences in the way that distributions and dividends are taxed.
When are the due dates of the estimated payments?
April 15th for Q1 (Jan – Mar)
June 15th for Q2 – (Apr - May) ** only 2 months
September 15th for Q3 – (Jun – Aug)
January 15th of the following year for Q4 – (Sep – Dec) – Pay as much as you can before this date to minimize the failure to make estimated tax payments penalty!
Where can I pay the estimated taxes, online?
You can use www.EFTPS.gov and (for Mass residents) MassTax Connect to make online payments. You can also ask your tax accountant to prepare vouchers for you when he or she is preparing your taxes or get the vouchers online by searching for 1040-ES (make sure you get the right tax year) and your applicable state vouchers.
PRO TIP – Estimated payments from your sole proprietorship, LLC, Partnership, and S-corporation profits should be made from your personal bank account.
Why should I pay them?
You won’t go to jail if you don’t pay estimated taxes on time (or at all) but a few things can happen.
One thing that can happen is penalty; form 2210 calculates it but following this form can be tough. The easiest rule of thumb is 2.66% of your annual underpayment (this method applies if you made no estimated payments for the year).
Another thing, If you are in an installment agreement or involved with an offer in compromise with the IRS for past due taxes then a failure to make estimated payments can jeopardize these agreements or applications.
How can I estimate my tax liability?
There are many variables to the amount of tax due (think tax brackets and itemized deductions) that can create complexity when calculating estimated taxes. It gets more complicated the more money you make (like if you are maxing out Self-employment taxes) and there are often other factors (like W-2 wage over/under withholding or rental property income) to consider.
To get in the ballpark for estimated tax, you should know your income sources and estimated tax bracket. If you think that your business income is going to be in the 25% tax bracket (perhaps because of your spouse’s income) then it may be reasonable to stash away 40% for Federal and State taxes.
How much is the minimum that will keep me out of penalty and How do I know if I need a tax professional?
If you are going to make more money than last year then you can pay 100% of what you had to pay last year or 90% of what you think that you are going to owe this year, divided by 4, on the due dates of the estimated payments. This will get you into a “safe harbor” to avoid penalty. It follows that you should have some liquid cash for the additional tax you will need to pay on April 15th.
If you feel like your taxes are going to be significantly less and you have better things to do with your cash then earn 0% interest from the government (like grow), then talking to a tax professional would be a good choice.
Lyle Phipps, CPA
for Prepared Accounting PC