Most people get taxes taken directly from their bi-weekly paychecks. This isn’t the case for business owners, who have to pay taxes on a quarterly basis year-round. It’s intimidating at first, but a few simple lessons will make this process simple. There are differences in how this works for businesses vs. self-employed individuals, so read each section carefully.
Estimated Taxes for Corporations
One way or another, every business person makes estimated tax payments on their income. If your business is a pass through entity, you make estimated taxes for your personal tax return. A corporation, on the other hand, pays taxes on its income and submits estimated business taxes periodically during the year. Here’s an example for a corporation:
Openmeadow Gifts, a C corp, earned $100,000 in year one and paid $20,000 in taxes. Bob, the majority owner of Openmeadow, works with his CPA to plan for estimated tax payments periodically during the year. Based on his profit estimates, Bob thinks that Openmeadow will earn $120,000 in year two and pay $24,000 in federal taxes.
At the end of year two, Openmeadow’s CPA calculates a tax liability of $25,600. The company records the $24,000 in estimated tax payments on the tax return, and pays the remaining $1,600 when the corporate tax return is filed
Estimated Taxes for Individuals
Pass through entities do not make tax payments. Because the income passes through to each owner, it’s up to the owner to plan their own tax payments. Owners in sole proprietorships, S corporations and partnerships make estimated tax payments for their personal tax returns.
As an example, Silverscreen Productions pays Julie $40,000 for her work as a producer in year two, and Julie also earns $20,000 from other clients. Julie works exclusively as an independent contractor, so her payments do not include any tax withholdings for year two.
In year one, Julie paid $10,000 in federal taxes on $50,000 in income, or a 20% tax rate. Based on a conversation with her CPA, she expects to pay the same 20% tax rate in year two, or $12,000 in taxes on $60,000 in income. Julie pays estimated taxes periodically during the year.