How to Calculate and Pay Quarterly Estimated Taxes
If you run your own business, chances are you need to pay quarterly estimated taxes. While sending a tax payment to the IRS every three months may sound like a hassle, it can actually benefit your business.
Done right, quarterly estimated taxes give you a chance to get a better grip on your financials, and avoid nasty tax season surprises. This overview gives you everything you need to know to file estimated taxes the right way.
What are quarterly estimated taxes?
Quarterly estimated taxes include all the taxes your business owes the IRS for the year, split up into four parts. Rather than paying all your taxes in a lump sum at the end of the year, you pay them in installments over the course of the year.
- Have your own business, and
- Expect to owe over $1,000 in federal taxes (or $500 for corporations)
you are required to pay estimated taxes.
Remember: You’re paying taxes for the current year in which you’re operating. Since you haven’t filed your tax return yet, it’s impossible to say exactly what you owe.
That’s where the “estimated” part comes in. If you pay too much, you’ll get the money back as a tax refund. If you pay too little, you could get charged extra by the IRS.
Luckily, there are ways to make sure you don’t get penalized for underpaying. We’ll cover that in a minute.
The four benefits of paying your quarterly estimated taxes
If you’re thinking of ignoring quarterly payments altogether, and just crossing your fingers and paying a lump sum at the end of the year, pause to reconsider. Estimated taxes don’t have to be complicated—and there are ways you benefit from paying them.
1. You avoid penalties
The IRS is serious about quarterly payments. If you ignore the rules and pay in a lump sum, you are pretty much guaranteed to get penalized. For the sake of your business, avoiding payments isn’t worth it in the long run.
2. It saves you from end of year sticker shock
Paying quarterly means that, at the end of the year, you aren’t presented with a jaw-dropping tax bill. Yes, you may underpay, and need to make up the difference—but that’s pennies compared to dealing with all your taxes at once. And it’s less of a dent in your cash flow to budget for quarterly payments than to pay one large sum at the end of the year.
3. You’ll get to know your cash flow
In order to make quarterly payments, you’ve got to stay on top of your cash flow. If your business is in the early stages of growth, and you don’t have many expenses to worry about, cash flow may not be at the top of your mind. But as your business gets bigger, making sure you have enough cash on hand to cover expenses becomes a more complex task. Managing your cash flow now for the sake of planning quarterly taxes sets up good financial practices for the future.
4. You can get cozy with your bookkeeper and accountant
It’s wise to plan cash flow with the help of your accountant and bookkeeper; they can help you avoid under- or overpaying. Working with an accountant puts your financial practices under scrutiny—which is a good thing. Having an accountant look at your books when your business is still starting out, and getting their help, puts you in the habit of keeping your bookkeeping organized. That makes it easier to make important business decisions, file your taxes, and plan for growth.
How to estimate quarterly taxes
Here are the steps you need to take to estimate your quarterly taxes for the year.
- Create a projected income for the year—either by creating pro forma financial statements, or looking at your income from the previous year.
- Subtract any anticipated above-the-line deductions from your estimated income.
- Apply income tax and self-employment tax to the total. Income tax varies according to your tax bracket. Self-employment tax is 15.3%.
- Divide that amount by four. The result is how much you need to pay the IRS each quarter.
As a formula:
Thank goodness for the safe harbor rule
If you’re starting to feel anxious about underestimating your income for the year, underpaying estimated taxes, and getting penalized by the IRS, have no fear. The safe harbor rule is here to save the day.
Put simply, the safe harbor rule means that, so long as you pay the same amount in taxes that you paid last year, you won’t be penalized by the IRS—no matter how much you underpay.
This rule works for up to $150,000 in pre-tax income. If your business crosses that threshold, you must pay the equivalent of 110% of last year’s taxes in order to qualify for safe harbor.
Here’s how that affects your tax planning. If you’re expecting a slower year, and estimate you’ll pay less in taxes than the previous year, you may be better off just paying 100% of what you did last year. So, if your business owes more income tax than you expected, and you underpay, you won’t be penalized.
How to pay quarterly estimated taxes
The way you pay quarterly estimated taxes varies according to your business structure.
Sole proprietorships, partnerships, and LLCs filing as partnerships
To pay your quarterly estimated taxes by mail, fill out and send Form 1040-ES, along with a check, to your nearest IRS office.
You can also pay online or by phone using the IRS Payments Gateway.
To pay your quarterly estimated taxes by mail, fill out and send Form 1120-W, along with a check, to your nearest IRS office.
To pay online, use the Electronic Federal Tax Payment System
Quarterly estimated tax deadlines
The quarterly estimated tax deadlines for 2020 are:
- January 15, 2020: Last quarterly tax payment (4/4) for the 2019 tax year due.
- April 15, 2020: First quarterly tax payment (1/4) for the 2020 tax year due.
- June 15, 2020: Second quarterly tax payment (2/4) for the 2020 tax year due.
- September 15, 2020: Third quarterly tax payment (3/4) for the 2020 tax year due.
- January 15, 2021: Fourth quarterly tax payment (4/4) for the 2020 tax year due.
Paying taxes is rarely ever fun. But that doesn’t mean it needs to be complicated. Take some time now to figure out how everything works, and you’ll be well on your way to handling estimated taxes like a pro.
Our partners at Bench are experts in small business bookkeeping and tax filing. Need help staying on top of quarterly deadlines? They can help.