Understanding Quarterly Estimated Taxes

kathryn by Kathryn Hawkins on March 24, 2011

Since you’re a business owner, you don’t have any employer withholding tax payments from your paycheck. That means you’re responsible for sorting out how much of your income should go to Uncle Sam on your own — and worse yet, you’re likely responsible for doing it four times a year, on the 15th of each January, April, June, and September. (Check out these guidelines to find out if you need to be making quarterly payments.)

Quarterly estimated taxes aren’t much fun, but they don’t have to be the bane of your existence. Here are four ways to cut the hassle:

1)   Create a separate bank account for your tax payments, and move 30 percent of your gross income into that account as soon as it has been received. This will keep you from spending money that the IRS may decide to lay claim to.

2)   If your business is more than a year old and last year’s adjusted gross income was $150,000 or less, look at your previous year’s 1040 “total tax” entry form, and subtract any expected withholding for wages or other factors to come up with the total amount of your estimated tax payment. Divide that number by four, and send in a check for that amount each quarter. Even if you earn more than you did the previous year, you won’t be penalized by the IRS because this is considered a “safe harbor” payment. (Learn more at Bankrate.) If your gross income last year exceeded $150,000, you should plan to pay at least 110% of last year’s payment.

3)   If your business is seasonal or doesn’t have consistent cash flow for some other reason, you may use the “annualized” payment method. This allows you to pay a percentage of that quarter’s earnings, rather than paying the same amount each quarter. See IRS Form 2210 [PDF] for more details.

4)   Use the Electronic Tax Federal Payment System (EFTPS) to file your estimated quarterly tax payments online. You can even set up automated payments that will deduct the taxes owed from your checking account or charge the payment to a credit card.

If your revenues are better than the previous year, the IRS may well inform you that you owe additional tax. On the other hand, you may find yourself looking at a nice refund if your business doesn’t do as well as the prior year. Either way, with careful planning, quarterly estimated taxes don’t need to be anything more than a minor annoyance.