Income tax systems in the United States are called pay-as-you-go-systems. That means you pay your income tax throughout the year either by having your employer withhold your tax and pay the government on your behalf or if you are self-employed, by you making estimated tax payments. Small business owners, which include S-Corp shareholders, and the self-employed have historically been less compliant which leads to a greater number of penalties and higher penalty amounts than taxpayers as a whole.
Estimated tax payments are required when you expect to owe at least $1,000 in the upcoming tax year after subtracting withholdings and the lesser of 90% of the tax on your upcoming tax year return or 100% of the tax on last year’s return. For example, if you owed $10,000 in last tax year and you expect to owe $10,000 this tax year, and you have a spouse with a job or second job with anticipated employer withholdings of $9,000, you would not need to make estimated tax payments because you would have already paid 90% of your tax through employer withholdings. If you do not have any employer withholdings from a spouse’s job or your own job then you would need to make estimated tax payments of $10,000, $2,500 per quarter, throughout the year to avoid underpayment penalties.
According to accounting and tax research, one of the main causes of the underpayment penalty for the self-employed and small business owners is a lack of cash flow. The government requires quarterly tax payments on April 15th, June 15th, Sept 15th and Jan 15th next year. If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return.
My advice to business owners and the self-employed is to make smaller monthly payments instead of making larger quarterly payments that may put your business in a tight cash flow crunch which can then cause an underpayment tax penalty. Smaller monthly payments can be more manageable and the IRS does not prevent you for doing so as long as the total quarterly tax is paid by each quarterly deadline. Check with your accountant and see if this method doesn’t save you money in the long run.
[schema type=”person” name=”Steve Webster” city=”Sellersburg” state=”Indiana” postalcode=”47172″ ]