Do you have trouble calculating quarterly estimated tax payments? Here are some helpful tips to make the process much easier and less stressful.
If you’re newly self-employed and unfamiliar with the IRS’ estimated tax payment schedule, here are the due dates for quarterly estimated tax payments (made via Form 1040-ES): April 15, June 15, September 15, and January 15 (of the next year).
If your business income fluctuates from year to year, as is often the case for the small business owner, it can be difficult (if not impossible) to know your tax liability until the year is over. So many self-employed people end up being too conservative. They fear to have a balance due on their tax return and pay way too much-estimated tax during the year. They end up just like the W-2 employee who has too much income tax withheld from his/her paycheck. The result — the self-employed person also gets a large refund and has given the IRS an interest-free loan of his hard-earned money. Not good!
The self-employed person has two options to avoid overpayment of estimated tax.
Do your best to track your income and expense during the year. If you are running a successful small business, you should be recording your income and expenses each month, and you should be able to produce reports that tell you exactly how your business is doing each month. Either you are doing this yourself with the help of a software program, or you are paying a bookkeeper or accountant to do this.
The point: if you don’t know what your bottom line is every month, you are making a big mistake! If you are waiting until the end of the year to see what the numbers look like, you are mismanaging your business.
This monthly financial summary is essential both from a business management/cash flow standpoint and also from a tax standpoint. The experts at Hillhurst Tax Group go as far as to state that from a tax standpoint, once you know your profit for a given quarter, you can then calculate the resulting tax liability on that quarter’s profit, and you can make a reasonably accurate quarterly estimated tax payment instead of just “winging it” and paying too much (or too little).
Here’s another great way to take care of your quarterly estimated tax payments. Option 2 is what the Tax Code calls “The Safe Harbor Method,” defined as follows:
The Tax Code says that most taxpayers can calculate the minimum amount of estimated tax by paying the previous year’s tax liability in the current year. Let’s say you are trying to figure out how much-estimated tax to pay for this year. Let’s also assume your previous year’s tax liability was $10,000. You take the $10,000 and divide it by 4, and you would pay $2,500 per quarter.
Now that wasn’t too hard, was it? As you can see, this is a much easier method to use than Option 1, because it takes less time to calculate.
There is another advantage to The Safe Harbor Method: if your current year income (and resulting tax liability) increases, you can still pay the prior year tax liability amount for the current year and not incur any penalty or interest for having a balance …