Estimated taxes: When and how to make payments

Every tax season, business owners have to sort through various small business tax forms, from 1099 to W-2 forms. Sometimes, making sense of your taxes seems like a job in and of itself, especially if you discover that you owe money come filing time.

If you expect to owe money come tax time, the government will likely make you pay estimated quarterly tax payments. But by paying quarterly, you avoid penalties and shouldn’t owe at the end of the year.

Let’s look at what quarterly estimated taxes are, who pays them, how to calculate them, and payment strategies. 

Who has to pay quarterly estimated taxes?

Employees have taxes withheld from their paychecks, but individuals like independent contractors need to make quarterly payments.

However, you do not have to pay taxes every time you receive income. Instead, you can make tax payments in quarterly installments. These quarterly estimated taxes are for any income tax you owe, as well as self-employment tax. 

Generally, all of the following individuals are responsible for paying quarterly taxes: 

• Independent contractors
• Sole proprietors
• Freelancers 
• Self-employed individuals
• Partners 
• S corporation shareholders 

There are a few additional qualifiers that determine whether you’re responsible for making quarterly payments. In particular, an individual who expects to owe over $1,000 in taxes needs to make quarterly tax payments. For corporations, the threshold is $500 in taxes annually. 

How to avoid having to make estimated tax payments

If your tax withholdings equal 90% or more of what you will owe for the year, you likely won’t need to file quarterly taxes. Thus, you can use income tax withholding to avoid paying quarterly taxes if one or more of these applies: 

• You have a working spouse: If you have a spouse with a job, your spouse can increase their withholding to cover your estimated taxes (regardless of whether they make more or less than you). 
• You have a W-2 earning job: Business owners, especially those with side businesses, may have part-time or full-time jobs. You can increase withholding from your W-2 wages to cover the tax on your business income.
• You have an LLC that elects S-corp status: If you have an LLC, you can opt to form an S-corp. This enables you to take a salary and have withholding taken to cover the taxes on your salary as well as your share of business profits.

When are estimated taxes due?

You pay federal income taxes on a pay-as-you-go basis. The burden is on you to pay estimated taxes four times a year. 

The quarterly due dates for estimated taxes are: 

• Jan 15 for income you earn during the fourth quarter (Sept. 1 to Dec. 31)
• April 15 for income you earn during the first quarter (Jan. 1 to March 31)
• June 15 for income you earn during the second quarter (April 1 to May 31)
• Sep. 15 for income you earn during the third quarter July 1 to Aug. 31)

Include these dates in your tax deadline calendar as a key part of any small business tax prep checklist.

Note that you may need to pay estimated taxes for your state as well. The due dates and requirements for many states may also differ from the IRS. 

How do you calculate quarterly taxes?

Underpaying your taxes triggers a penalty. Fortunately, the IRS provides two options for calculating and paying quarterly taxes:

Annualize your current year taxes

For this method, you’ll need to forecast your income and tax deductions for the year, and then calculate your tax obligation. You’ll want to ensure you’re paying at least 90% of the tax you expect to owe. 

This method can work well for those whose income varies throughout the year, like if your business is seasonal or you receive work during specific periods of the year and little to no work at other times. 

For example, let’s say that you have already paid your first and second installments of estimated taxes for the year. Then business picks up, and your income is 50% higher than the original estimate. You should adjust your third and fourth installments to take the added tax on this income into account.

Estimate taxes using prior-year tax

This method is simpler than forecasting your revenue and expenses for the current year. To use the estimate method, you look at what you paid last year and divide by four. That’s your quarterly installment payment for estimated taxes. 

For example, if your tax obligation last year was $5,000, your quarterly tax installment would be $1,250 ($5,000 / 4). 

Note that if your adjusted gross income last year was more than $150,000, the prior-year percentage increases to 110%. So if your income taxes were $5,000 last year, you’ll need to pay at least $5,500 ($5,000 x 110%) in the current year, or $1,375 per quarter ($5,500 / 4). 

If you expect your income in the current year to be the same or higher than last year, this is usually the easiest and safest strategy for figuring out your estimated tax. Just be ready to make up any shortfall in your taxes for the year when you file your return.

How do you pay quarterly estimated taxes? 

The IRS can penalize individuals and corporations who don’t file quarterly taxes on due dates. However, they make paying these taxes relatively easy. You can use Form 1040-ES to estimate your quarterly taxes and then file and pay online. You can also link your bank account to EFTPS.gov, known as the electronic federal tax payment system.

You also don’t have to pay estimated taxes just quarterly. You can make estimated tax payments weekly, biweekly, monthly, etc., as long as you pay enough by the end of the quarter. 

Estimated tax tips for business owners

One of the biggest struggles with quarterly taxes is not having cash on hand to pay them. Business owners use their income to pay creditors, make investments to grow the business, and more. But business owners and independent contractors must remember that anything they earn is taxable.

Here are some key tips for business owners and sole proprietors when it comes to estimated taxes: 

• Know that all your income is not fully spendable: Like employees who have taxes taken automatically from their paycheck, those paying estimated taxes must do their own “withholding.” For example, if you’re a freelancer who collects $2,000 for a project, know that a portion will need to go toward estimated taxes.
• Create an “estimated taxes” account: Separate funds for estimated taxes from your other business funds and hold the money in a different or cash reserve account. This will prevent you from using the money for other purposes.
• Work with a tax professional: Your accountant or other tax professional can monitor your income and expenses. They can provide you with tax advice about changes you need to make to your estimated tax payments.

An expert can also help you maximize your tax breaks and avoid missing other important tax deadlines.

Find peace of mind come tax time

Perhaps the best lesson to learn when filing small business taxes is that tax laws and rates can change yearly. Whether you’re an independent contractor or a small business owner, you’ll want to stay up-to-date on current tax laws and IRS regulations. 

Accounting software for self-employed individuals can help you manage your expenses, as well as estimate and file your taxes.