For new business owners, the tax rules can be confusing and even overwhelming. Just look at estimated payments.
What’s the point of this?
Well, the US has a pay-as-you-go tax system; in other words, the IRS collects taxes as you earn income. But for those who are employees, the employer will handle this by withholding amounts from your paycheck for federal and state taxes, as well as payments for Social Security and Medicare.
Yet things may be different for someone who is self-employed. If he or she does not setup payroll, then the IRS will want to see estimated payments for the taxes owed.
Now there are some exceptions. For example, you do not owe estimated payments if:
- You paid zero taxes last year (say because you were unemployed or your business lost money)
- You will owe less than $1,000 for the tax year, after accounting for refundable credits and withholding and…
- The taxes paid will be at least 90% of the tax you owe for the tax year or…
- The taxes paid this year will be at least 100% of the tax on last year’s return (it is 110% if your adjusted gross income is over $150,000 or $75,000 if you file a separate return)
No doubt, there are a lot of moving parts. But things can be boiled down to this: The IRS essentially wants to make sure that — if you owe $1,000 or more — you should pay at least of all of last year’s amount or 90% of this year’s.
But let’s say you don’t do this? For the most part, the consequences are not severe. You will owe an underpayment penalty, which is an interest charge (and no, you will not be thrown into jail!)
Despite this, it is still a good idea to make estimated payments. Besides saving a few bucks, you will also avoid something that many business owners fall victim too: not having enough money to pay taxes when April 15th rolls around.
So to make an estimated payment, you will need to fill out a simple voucher, called Form 1040-ES, or you can call the IRS to make the transaction. The due dates are on April 15, June 15, September 15 and January 15 (yes, the next deadline is on Wednesday).
The good news is that it is not too tough to come up with the amount for your estimated payments. Of course, a tax app like Intuit ’s TurboTax makes the process easy. Or, you can use your last year’s return to come up with the number (for more on this, you can check out here for my simple approach).