As a small business owner, you have to make estimated tax payments to the Internal Revenue Service throughout the year (about once a quarter). This makes it easier to afford the taxes you owe rather than have a lump-sum balance due at tax time. As a business owner, I will share with you how I have been dealing with estimated taxes for the past 10+ years.
Estimated Taxes for Business
Not only is it important to satisfy your overall tax liability for each year as a self-employed individual or a business owner, but you want to pay enough taxes to avoid additional penalties on top of what you owe. Understanding the consequences of paying your estimated taxes late (or not at all) is vital if you want to stay on the right side of the federal government and not go into debt with a huge tax bill after you file your taxes for the year.
Taxpayers must generally pay at least 90 percent of their taxes throughout the year through withholding, estimated tax payments or a combination of the two. If they don’t, they may owe an estimated tax penalty. — IRS.gov
Estimated Tax Payment Due Dates
Estimated tax payments are due about once a quarter (but not exactly). Here are the due dates for 2019
|Payment Period||Due Date|
|Q1 = January 1 – March 31||April 15|
|Q2 = April 1 – May 31||June 15|
|Q3 = June 1 – August 31||September 15|
|Q4 = September 1 – December 31||January 15 of the following year.|
Some important notes
- Q2 is based on only two months of taxable income
- Q4 is based on four months of taxable income and due the following year
IMPORTANT: You will also have to make quarterly estimated tax payments for your state government — so be sure to check their specific rules by searching “[state name] + quarterly estimated taxes” — for example, “Virginia quarterly estimated taxes.”
How to Calculate Your Estimated Tax Payments
If you do not have a tax accountant preparing your taxes, there is an easy way to calculate your estimated tax payments. You can do this even if it is your first year in business and you can use the same method for both federal and state estimated taxes.
1. Calculate Your Effective Tax Rate
First, look at your previous year tax return and look for these two amounts: Taxable Income and Total Tax. Your Effective Tax Rate is
Effective Tax Rate = Total Tax ÷ Taxable Income
Effective Tax Rate = $16,500 ÷ $100,000 = 16.5%
You can also you a simple tax calculator like this one at SmartAsset.
2. Calculate Your Taxable Income for the Period
Let’s say you’re trying to pay your Q1 estimated taxes; you need to add up all your taxable income that is not subject to withholding and subtract the total expense from January 1st to March 31st. For example,
- A = you work full time and made $10,000 in Q1 from your job
- B = You have a side business that made $25,000 in Q1
- C = Your side business costs $10,000 in expenses in Q1
You would calculate the Taxable Income for Estimated Taxes purpose as follow
Taxable Income = B – C = $25,000 – $10,000 = $15,000
Your taxable income is your profit, or cash flow, for the period. You can ignore your full-time income because your employer already took care of the tax withholdings.
3. Calculate Your Tax Owe
Tax owe for the period is calculated as follow
Tax Owe = Taxable Income x Effective Tax Rate = $15,000 x 16.5% = $2,475
You can repeat the same process for each quarterly payment and the State calculation as well. This is a very simplified version, but it has worked well for me over the past 10+ years I have been doing this.
Late Payment Penalty
The good news is that as long as you pay more than last year’s total taxes or at least 90% of what you owe, it’s hard to get penalized according to the IRS.
If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. — IRS.gov
Penalties are calculated using the IRS Form 2210. The basic equation is
Penalty = Total Underpayment for the Year x 0.03603
If you pay the tax you owe before April 15th income tax return due date; the IRS will reduce the penalty as follow
Penalty Reduction = Total Underpayment for the Year x Number of days paid before 4/15/19 × 0.00016
As a business owner or a side hustler, it is easy to avoid paying a tax penalty on your extra income as long as you keep up with the estimated payments. The process is easy enough to do it yourself, but if you’re unsure, consult a tax professional to help you with the calculations and payments.
Also, remember that you have to do this for both the IRS and your local tax authority.
Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.