As a small business owner, you normally have to make estimated quarterly tax payments to the Internal Revenue Service throughout the year. This makes it easier to afford the taxes you owe rather than have a lump-sum balance due at tax time. It also helps the government handle the influx of payments throughout the year rather than all at once. It is also generally more affordable for the small business owner to pay taxes on the money they are earning periodically; however, for some it can be difficult to meet these quarterly obligations. Your ability to pay depends on how profitable your company is on a month to month basis and what your current cash flow situation is.
Not only is it important to satisfy your overall tax liability for each year as a self-employed individual, but you want to pay before each deadline to avoid additional penalties on top of the tax you already owe. Understanding the consequences of paying your estimated taxes late (or not at all) is important if you want to stay on the good side of the federal government and not go into debt with a huge tax bill year after year. Here is a basic overview of what you need to know:
If you do not have a tax accountant preparing your tax paperwork for you, you can still calculate the estimated amount of taxes you would owe by using your total tax liability from the year previous and dividing that number by 4. You are responsible for paying 100% of the total liability you had from last year if your income is below $75,000 even if you anticipate making less money.
If you earn over $75,000, you are required to pay 110% of the tax liability as estimated taxes. This is known as the safe harbor rule as it can be difficult to anticipate how well or poorly your business will perform this year. If you experience rapid growth, paying your previous year’s tax liability (or 110% of it) will protect you from penalties.
If this is your first year in business you will need to track your quarterly revenues and expenses to calculate how much tax you owe. Even if you are unsure if your payment is 100% accurate it is best to send something in rather than just wait until the next quarter to accurately pay for the previous quarter.
Estimated tax payments are due quarterly. The standard dates for these payments are:
That having been said, always check the IRS’ guidelines in Publication 505. If you miss these deadline dates, even if you send in payments that are larger than your estimated requirements, you may still be subjected to a penalty. For small business owners who have income that varies from month to month, a waiver may be granted to rescind the penalties incurred from late payments. A form must be completed by the tax payer to request this waiver of penalties. The annualized income installment method is found on Form 2210.
Penalties are assessed based on the amount of time you are late. The IRS calculates the penalties by dividing the annual interest rate by 365 days. The result is multiplied by the total number of days the estimated tax payment is late. That percentage is used to calculate the amount you will pay in penalties.
Penalties owned on estimated taxes must be calculated on IRS Form 2210. If you did not make any estimated tax payments during the year, all four payments will be considered late and will incur a late penalty charge. If you paid part of your taxes through the year but was not able to make the full amount due (you owed $600 quarterly but only paid $400 quarterly) you would incur a penalty only for the amount you failed to pay.