Alright kids, it’s September and you know what that means… it’s almost the end of a quarter!
Seeing as we’re days away from that time of year when entrepreneurs are reminded about quarterly estimates again, I figured now was my time to shine. *
* I just want to make you aware that TODAY, on the day I write a post about quarterly taxes, my Q key is broken. It had an unfortunate run-in with a Leinenkugel cranberry ginger shandy. Nevertheless, I’ve powered through this post, all Qs accounted for, to make sure that it’s timely and helpful. I hope you’re appreciative.
Damn you, Leinenkugel.
There are a lot of questions rolling around about quarterly estimated tax payments.
Estimates are one of the more confusing tax issues for new business owners. In this post, I’m going to give you the run-down on why estimated payments exist, who needs to make them, how precise the “estimate” needs to be, and how to make the payments correctly and on time. I also put together a downloadable tax calendar for you so you don’t miss any important deadlines going forward.
Why are estimates even a thing.
In the US of A, if you earn money, the IRS (and probably your home state) want some. And they want it immediately.
For most people, this means that every time they’re paid, their employer keeps (“withholds”) a portion of their payment and then pays it to the government. Other sources of income like pensions, retirement plans and gambling winnings have income tax withheld for you many times, also. Easy peasy.
Some sources of income, though, do NOT withhold any taxes. Dividends, rent payments, and business income are the most common.*
* Fun fact – you don’t owe tax on money that’s gifted to you (although the giver might), but you DO owe tax on any money you find. Think about that next time you get your hopes up about that lockbox you find in grandma’s basement.
For these types of income, the IRS and most states want you to pay taxes on that money throughout the year, not just when you file your returns.
Enter quarterly estimates. They’re the government’s way of getting their money as soon as you owe it to them. A sort of pay-as-you-go system. Ideally, people know what they made, have a good idea of what they’ll owe, and pay their taxes throughout the year so that they owe as little as possible once they file their return.
People who don’t pay their quarterly estimates run into three main problems:
- A Big Ole Tax Bill: What you don’t pay now, you’ll need to pay later. There are some who sit firmly in the “But it’s basically like an interest-free loan from the government!” camp, but for most people, a big balance due at the end of the year can throw off their budgeting game for months. It’s better to stay ahead, pay the tax as you owe it, and avoid cash flow problems by spending on borrowed dime.
- Interest: Speaking of interest… IS holding onto your money interest-free? It’s true that interest on tax balances doesn’t normally kick in until after your tax return is due. The very day that a payment is late, thought, it turns on the interest clock, and that shit compounds daily. Also, filing an extension for your tax return gives you an extra six months to prepare your return, but it does NOT give you more time to pay. The IRS does not play games when interest is involved.
- Penalties: The cherry on top. Penalties are more than a little bit confusing to calculate (obv), but all you need to know is that they suck. And there’s no reason to pay the government any more than you already do. End of story.
do I have to make quarterly payments?
If you have a source of income on which you DON’T have regular withholding, the answer is probably yes. If you were to check IRS Publication 505, you’d find the following.
Which is basically a long, boring way of showing that if you 1) think you’ll owe at least $1k to the IRS for the year, and 2) aren’t having enough money withheld to cover those taxes, the answer is yes.
I want to stress the words “enough money” in that last sentence because this is sometimes where business owners mess up.
Sometimes entrepreneurs think that once they start running payroll, estimates don’t apply to them. That once they’re taking a salary, the withholding that they pay is an insurance policy against penalties and interest imposed by the greedy powers-that-be.
Keep in mind, though, that the normal withholding that comes from payroll processing only accounts for the salary amount… NOT for any additional income you’ll make from the company. If your business is profitable (and I surely hope that it is), there may be pass-through income from your company that is over and above your salary amount. If that’s the case, you may still be a candidate for estimated payments.
Okay, so I Do need to make quarterly estimates. How much are we talking?
There are two calculations you can use to determine how much of an estimate you need to pay.
- 100% of what you paid last year. Easy enough to figure out. Just look at last year’s tax return. This is what they call a “safe harbor” rule. Even if you make a lot more money this year, as long as you base your estimated payments off of last year’s tax liability, you’re in the clear. That is, of course, unless you made over $150k last year, in which case you need to use 110% for this calculation, because fuck you guys, let’s make it more complicated!
- 90% of what you expect to owe this year. This is most likely the number you would use if it’s your first year in business, or if you think you will be making less money this year than you did last year.
The IRS only asks that you pay the lower of the two amounts. Reasonable, right?
There is, of course, a worksheet with a much more tedious and drawn-out calculation of estimated payments supplied here by the IRS. There are a lot more numbers that will, more or less, bring you to the same calculation. Don’t say I didn’t warn you.
If I want to hold onto MY money a bit longer, cAN I make one big estimated payment towards the end of the year to catch up?
The IRS: YOU WOULD LIKE THAT, WOULDN’T YOU?!
The purpose of estimates is so that the IRS can collect money as it’s due, and paying everything at the end of the year doesn’t make it better just because it’s an estimate. Penalties are calculated separately for each quarter that you underpaid, so if you owe them, you’ll need to make all of them.
where do I pay?
Luckily enough for us, the IRS graciously makes it easy as pie to give them money.
You can make payments via bank transfer OR credit/debit card straight through the IRS Payment Gateway. If you’re a larger company or want/need the ability to pay multiple different types of tax online, you could also enroll in EFTPS.
For paying estimates to your state, you’ll need to poke around their Department of Revenue website. Nowadays, most of them will also have an online payment option. If not, they should at least have instructions on where to send a check.
To make sure you don’t miss any deadlines (for estimates or otherwise), I’ve put together a calendar of upcoming due dates that you can view here.
I hope this was helpful, and I want you to tell me if it wasn’t. Leave a comment below with questions, comments, and snide remarks. I’ll respond to every one. I promise.
Go forth, my children, and estimate.