If you work for an employer, you likely think about paying your taxes once a year. When you start earning money for yourself, however, everything changes.
Although tax returns are only due once a year, the IRS wants you to pay your taxes on a much more frequent basis. As a result, most self-employed people need to pay quarterly estimated taxes to the IRS. Estimated taxes can also apply to people who aren’t self-employed, but earn income that doesn’t have tax withheld by an employer (such as rental properties, dividends, interest, etc).
The name of these taxes, quarterly estimated taxes, is a mouthful but it’s pretty straightforward. They’re calculated based on your estimated revenue and tax liability, and they’re paid once every quarter.
Here are the key facts that every new entrepreneur should know about federal estimated taxes. State tax requirements vary widely, so check with your state tax department to get the full scoop for your situation.
- Do I need to make quarterly estimated tax payments?
- How do I calculate estimated tax payments?
- When and how do I make quarterly tax payments?
Do I need to make quarterly estimated tax payments?
If you earn income that doesn’t have tax withheld by an employer, you likely are required to make quarterly tax payments to the IRS. There are two possible exceptions, however.
The first exception is fairly rare, and it only applies if you meet all of the following criteria:
- You didn’t have any tax liability in the previous year (meaning your total tax was zero or you didn’t have to file a return)
- You were a U.S. citizen or resident for the whole year
- Your previous tax year was 12 months long
The other exception is considerably more common. If you will owe less than $1,000 in taxes at the end of the year, after you subtract your other withholdings and credits, you aren’t required to pay estimated taxes each quarter. For example, this exception may apply if you only earn a small amount from your business, or if you earn the bulk of your income from an employer who withholds enough to pay taxes on all your income (including your business income).
How do I calculate estimated tax payments?
Before you can answer that question, you have to answer this one: Do you want to prevent yourself from owing taxes on April 15, or do you simply want to avoid paying a penalty to the IRS for underpayment?
If your goal is to avoid paying a penalty to the IRS, you don’t need to worry too much about the calculations. That’s because the IRS has a series of rules, commonly called “safe harbor rules” that allow most taxpayers to avoid the underpayment penalty if any of the following are true:
- You owe less than $1,000 in tax after subtracting your withholdings and credits.
- You pay at least 90% of the tax for your current year.
- You pay at least 100% of the tax liability shown on your tax return for the prior year. (Special rules apply if at least two-thirds of your income is from farming or fishing, or if your income is above a certain level.)
Since that’s a whole lot of tax jargon, let’s look at an example. Let’s say it’s your third year in business, and your revenue has grown substantially. If you earned $50,000 last year and ended up paying $10,000 in taxes, you only have to pay $10,000 in estimated taxes even if your revenue has increased to $75,000.
This approach simplifies the math involved quite a lot, but just paying enough to avoid a penalty won’t prevent you from ending up with an unexpected bill when you do file your yearly return. To revisit the example above, let’s say your tax liability is now $16,000. If you only paid enough to avoid the penalty ($10,000), you’ll need to come up with another $6,000 when you file your yearly tax return.
If you want and avoid owing more tax at the end of the year, you’ll need to estimate your tax liability as accurately as possible.
You can get help from an accountant, or if you’d like to handle this task yourself, you can use the IRS Estimated Tax Package (which includes the form, instructions, and other information you need). You can also use tax preparation software that’s designed for small businesses; most of these services offer calculators and tools specifically for handling estimated taxes.
When and how do I make quarterly tax payments?
Quarterly estimated taxes are due four times a year, but they aren’t evenly spaced. Here are the payment deadlines for the 2019 tax year:
- April 15, 2019
- June 17, 2019
- September 16, 2019
- January 17, 2020
You can reference these dates on the IRS website here. When you’re ready to make a quarterly payment, you can do so online, either with a credit card or by giving the IRS your bank account and routing number. You can also mail in a check or pay by phone.
Disclaimer – This content is for informational purposes only and does not constitute tax, accounting, legal, or other professional advice. Please do not rely on this content for any specific purpose without obtaining personalized professional advice.