If you’re self-employed, paying estimated taxes is old hat by now. But, what if this is your first time doing it? Here’s how to calculate, pay estimated taxes for the first time.
What are estimated Taxes?
When you’re self-employed, no taxes are withheld from your compensation by your clients or customers. Yet, this doesn’t mean you can simply wait until April 15 to pay all your taxes for the prior year.
The IRS wants to get its money a lot faster than that. The self-employed are required to pay taxes on their estimated annual incomes in four payments spread out over each year. These are called estimated taxes. These pay for both income
These pay for both income taxes and self-employment taxes (Social Security and Medicare taxes). The IRS imposes penalties if you don’t pay enough estimated tax.
You must pay estimated taxes if you are a sole proprietor, a partner in a partnership, or member of a limited liability company and you expect to owe at least $1,000 in federal tax for the year. Most self-employed people are sole proprietors.
A sole proprietor and their company are one and the same for tax purposes. Simply pay your estimated taxes out of your own pocket. You, not your business, pay the taxes.
You may not have to pay estimated taxes
You don’t have to pay any estimated tax this year if you paid no taxes last year. This applies no matter your income for the year. This only applies if you’re a U.S. citizen or resident for the prior year. Also, your tax return for that year must have covered the whole 12 months.
You also don’t have to pay estimated tax if you have a W2 job and the amount withheld will amount to at least 90 percent of your total tax bill. You can avoid paying estimated tax by increasing your employee withholding.
How much estimated tax to pay the first year you’re in business?
If you’re just starting your business, how do you know much to pay? You may have no idea how much money you’ll earn during the year. So, you won’t know how much tax you’ll end up owing.
Fortunately, you can avoid this issue. You won’t have to pay any penalties if the estimated tax you pay is at least the smaller of:
- 90 percent of your total tax due for the current year or
- 100 percent of the tax you paid the previous year or 110 percent if you’re a high-income taxpayer (those with adjusted gross incomes of more than $150,000 or $75,000 for married couples filing separate returns).
The easiest and safest way to calculate your estimated taxes is to simply pay 100 percent of the total federal taxes you paid last year. You should pay 110 percent if you’re a high-income taxpayer.
You can base your estimated tax on the amount you paid the prior year even if you weren’t in business that year. But, your return for the year must have been for a full 12-month period.
Divide the total amount of tax you had to pay for the year by four. You can round up this figure to an even number. That’s your estimated tax amount you should pay.
What if I know I’ll make less this year?
Yet, if you’re certain your net income will be less this year than last year, you may pay less estimated tax. Base your tax on your taxable income for the current year instead of basing it on last year’s tax.
There are many online estimated tax calculators you can use to determine your quarterly estimated tax payments based on your estimates. These calculators also come with tax preparation software.
Be sure to monitor your earnings during the year. If you estimated too high, refigure your estimated tax for the next quarter. If you estimated too low, adjust your estimated taxes for the next quarter.
The annualized income installment method
Another way to calculate your estimated taxes is to use the annualized income installment method. It requires that you separately calculate your tax liability at four points during the year—March 31, May 31, August 31 and December 31.
You must prorate your deductions and personal exemptions for these periods. You base your estimated tax payments on your actual tax liability for each quarter, instead of the entire year.
This method is often the best choice for people who receive income very unevenly throughout the year. You can pay little or no estimated tax for the quarters where you earn little or no income using this method.
If you use this method, you must file IRS Form 2210 with your tax return. This form shows your calculations. Calculating your payments using the annualized income method is complicated. So, use an online estimated tax calculator or one that comes with tax preparation software.
When to start paying estimated tax
You normally pay estimated taxes in four installments. Yet, you don’t have to start making payments until you actually earn income.
You can skip the first payment if you don’t receive any income by March 31. In this event, you’d ordinarily make three payments for the year starting on June 15. If you don’t receive any income by May 31, you can skip the June 15 payment as well.
The following chart shows the due dates and the periods each installment covers.
|Income Received for the Period||Estimated Tax Due Date|
|Jan. 1 through March 31||April 15|
|April 1 through May 31||June 15|
|June 1 through Aug. 31||Sept. 15|
|Sept. 1 through Dec. 31||Jan. 15 of the following year|
How to pay estimated tax
The IRS wants to make it easy for you to send in your money, so the mechanics of paying estimated taxes are very simple. You have several choices of how to pay:
- With a check sent through postal mail using IRS Form 1040-ES
- By electronic withdrawal from your bank account using IRS Direct Pay
- By credit or debit card—see the IRS website.
Paying too little estimated tax
The IRS imposes an interest penalty if you underpay your estimated taxes. The interest applies to the difference between how much you should have paid and how much you actually paid.
The IRS sets the interest rate each year. It’s currently about 3 percent. Many self-employed people decide to pay the penalty at the end of the tax year. It may be financially prudent to do so instead of taking money out of their businesses during the year.
If you do this, make sure you pay all the taxes you owe for the year by April 15 of the following year.
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MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.