It’s April 15th. Your tax return is due. Your small business did well last year so along with the return, a tax payment is due. But you didn’t make any estimated tax payments last year so your accountant informs you that along with the tax that is due, you also owe a whopping penalty and interest. Now what do you do?
ESTIMATED TAX PAYMENTS
The IRS expects everyone to pay their taxes throughout the year, not just at the end of it. It’s considered a pay-as-you-earn system. But unlike employees, who have taxes withheld from their pay checks each month, small business owners are expected to make estimated tax payments on a periodic basis. If you will be filing as a sole proprietor, partner, S corporation shareholder, or a self-employed individual, you generally have to make estimated tax payments if you expect your total tax liability for the year to be $1,000 or more.
If you are filing as a corporation, you generally have to make estimated tax payments for the corporation if you expect it to owe tax of $500 or more when you file its return.
UNDERPAYMENT PENALTY
If you do not pay enough tax through withholding or estimated tax payments throughout the year, you may have to pay a penalty as a result of the underpayment when you file your tax return. And, if you did not pay enough by the due date of each estimated payment you may still be charged a penalty even if you are due a refund when you file.
The IRS will calculate the penalty based on what you should have paid and what you did (or did not) pay for your quarterly estimated taxes. The penalty is typically 0.5% of the total amount you owe calculated for each month you haven’t paid it. That may not sound like a lot but it can compound up to a maximum penalty of 25%. Also, the underpayment may be subject to interest at the current rate of 3%.
HOW TO CALCULATE ESTIMATE TAX
Your accountant can help you determine what the quarterly payment amount should be or you can use the worksheet that accompanies IRS Form 1040-ES to estimate your tax payments. Alternatively, if you don’t want to take the time to estimate your income, deductions, taxes and credits for the calendar year 2015, you can base your estimated tax payments on your total tax due for the previous year.
If you expect your income this year to be less than or the same as last year, you can calculate your estimated payments for 2015 to total 90% of the tax shown on your 2014 federal tax return. Note that you may still owe money when you file your return in 2016 so you may want to base your estimated payments on 100% of your total tax due for 2014.
If you expect your income this year to be more than last year, then plan on paying 100% of your prior year’s tax bill. If your adjusted gross income for 2014 was more than $150,000 for married couples filing jointly and single taxpayers, or $75,000 for married persons filing separately, you will need to pay at least 110% of your previous year’s tax bill to avoid additional tax penalties.
The IRS prefers you to figure your total estimated taxes for the year then divide it by four and send in equal payments according to the schedule. However, if you have a seasonal business, such as landscaping, you can opt to use the annualized method instead. The annualized method allows you to look at each payment period independently and pay the tax in the period in which the income was earned. With this method, your estimated tax payments will be different for each period and will better reflect your cash flows.
The annualized method is a bit more complicated and requires some additional forms to be filed. Therefore, I suggest that you consult with a qualified tax accountant if you want to consider using this method.
WHEN TO PAY ESTIMATED TAX
For estimated tax purposes, the IRS divides the year into four payment periods and refers to them as quarterly payments – although they are not due at true quarterly intervals. Each period has a specific payment due date.
For 2015, if your tax year is the calendar year, the payment periods and due dates are as follows:
| For the Period: | Due Date: |
| Jan 1 – Mar 31 | Apr 15 |
| Apr 1 – May 31 | Jun 15 |
| Jun 1 – Aug 31 | Sep 15 |
| Sep 1 – Dec 31 | Jan 15 of the following year |
For fiscal year taxpayers, your payment due dates are:
- The 15th day of the 4th month of your fiscal year,
- The 15th day of the 6th month of your fiscal year,
- The 15th day of the 9th month of your fiscal year, and
- The 15th day of the 1st month after the end of your fiscal year.
If you file your 2015 return by February 1, 2016, and pay the rest of the tax you owe, you do not have to make the payment that is due on January 15, 2016. If your payment is mailed, the date of the postmark is considered the date of payment. And as usual with the federal government, if the due date for an estimated payment falls on a Saturday, Sunday or holiday, the payment will be considered on time if you make it on the next business day.
Using the Electronic Federal Tax Payment System (EFTPS) is the easiest way to pay your federal taxes. Go to www.IRS.gov to set up your account. You can pay your estimated taxes weekly, bi-weekly or monthly if it is easier for you just so long as you have paid enough in by the end of the period.
PREPARE IN ADVANCE TO MAKE YOUR PAYMENTS
Now that you know how much your estimated tax payments will be, be sure to set aside money every month (or week if you can) to prepare yourself to make the payment. Figure roughly 10% of your revenue every month. Open a business savings account and set up an automatic transfer from your checking to your savings account at regular intervals. When the transfer is automatic, it is more likely to happen because you don’t have to worry about remembering to do it.
If you complete an unusually large job or project and receive a big payment, send a tax payment to the IRS right away instead of spending all of the money. The object here is to pay less to the IRS by avoiding penalties and interest at year end.
Don’t find yourself in the same boat again next April. Start setting money aside now to make your required estimated tax payments. This way, you won’t be scrambling next year to come up with the money to pay your tax bill and you won’t have incurred additional penalties.