Taxes are “pay as you go” and not “pay at the end of the year”. Here is a super easy read to understanding estimated tax planning for your small business.
Disclaimer: Estimated tax planning is complicated. If you don’t figure things out correctly, you could end up paying penalties, facing a stressful tax balance at tax time, and possible other unpleasant situations. We recommend that you hire a tax professional to do your tax planning for you.
Estimated taxes – taxes are “pay as you go”, not “pay at the end of the year”
Remember when you got your first “on the books” job and received your first paycheck?
I’m sure you quickly saw that there was a big difference between your gross pay and your net pay. I bet you thought WTF?
Now that you are in business, you still must pay all these taxes, but now no one is taking it out of your paycheck for you.
If you don’t do this yourself, you will run into two problems:
- The IRS will charge you interest for holding on to the money that they are supposed to periodically collect form you for the treasury.
- You will likely spend all the money that you were supposed to pay in taxes on personal things, and you will be buried with an end of the year tax bill that you can’t pay. (I’m not judging you, it’s human nature, and life is expensive).
So you must plan to put this money aside and make tax deposits, at least on a quarterly basis. Note that you can pay more often than quarterly if you want.
I do. I find these tax payments very stressful to make, so the smaller, the better. I pay it in twice a month, just as if I was getting my first paycheck.
The government is a one third partner in everything you do
That’s the bad news on about how much you must pay. Don’t hold me to that amount exactly – it’s just a rule of thumb.
If you make a lot of net profit, your spouse has a high paying day job, or if you are single with no kids, you will pay on the high end. If your situation is opposite to as described above, you might pay less than a third.
So if you make $30,000 in net profit, put aside $10,000. If you make $120,000 in net profit, plan on paying Uncle Sam about $40,000.
Since it’s just a rule of thumb, you should hire a tax preparer to figure it out for you. If fact, that’s a real good idea, as the amount will fluctuate depending on several factors.
In general, however, you guess on about a third of your net profit (after expenses).
Pay in your taxes at least quarterly to avoid interest
The IRS used “odd” quarters for estimated tax payment due dates.. They use:
- April 15
- June 15
- September 15
- January 15 (of the following year)
There are three ways you can pay your estimated taxes.
One is to go to IRS.gov/payments.com (opens in a new tab).
This sounds like it would be the easiest way to pay, but it can be difficult to set up. To make an account, the IRS requires that you take a test to verify your identity. This is not an east test to pass. I failed it, and I’m a tax guy. They are going to ask you all kind of questions about past addresses and tax amounts.
If you get it set up however, it’s a very convenient way to pay.
The next option is to prepare form 1040es (estimated tax payment voucher) and send it in with a check. This is they way us non-millennials had to pay all of our bills. It was a real pain in the neck. You needed stamps, and stuff.
Form 1040es comes with easy to follow instructions, and that’s pretty cool, I guess.
Lastly, there are third party sites that let you pay by credit card. I know what you are thinking…
But they charge a fee – and it’s more than you get in points. So it’s totally not worth it. Still, if you wish to pay this way out of convenience, do a search for “pay the IRS pay credit card”.