Tax Season Never Ends for the Self-Employed
April 15 is the income tax filing deadline for U.S. taxpayers, but it’s not the only date that matters to business owners. Estimated tax payments for a given tax year are typically due in four equal installments: April 15, June 15, and September 15 of the current year, and January 15 of the following year.
There are nearly 28 million small businesses in the United States, which means many entrepreneurs and freelancers don’t have an employer that withholds taxes for them.1
That’s why sole proprietors, S-corporation shareholders, and other self-employed individuals who expect to owe $1,000 or more in federal taxes when they file their returns must make estimated tax payments. This involves a fair amount of guesswork, but calculations are typically based on the previous year’s tax liability.
Even employed individuals who receive income from other sources, including investments, could be subject to estimated tax payments if they will owe $1,000 or more after salary withholding.
Making accurate quarterly tax payments on schedule can help you avoid interest penalties for underpayment and keep you from falling behind with the IRS.
Stopping the Clock
Unfortunately, penalties begin accruing as soon as you miss one quarterly payment. The IRS charges interest daily until you catch up. The annual rate, currently 3%, is subject to change each quarter.
For planning purposes, keep in mind that underpayment penalties usually do not apply in the following two situations.
- If your withholding and estimated tax payments add up to at least 90% of your tax liability.
- If your withholding and estimated tax payments are at least 100% of the previous year’s tax bill, or 110% if your adjusted gross income exceeds annual thresholds ($150,000 in 2013).
Thus, employed taxpayers could help reduce or eliminate interest charges by increasing their salary withholding enough to offset estimated payments.
If your income tends to be higher at the end of the year, you may want to use the “annualized method” instead of making four equal payments. This way, estimated payments correspond to your cash flow, so you won’t face big installments on earlier due dates before you can pay them.
The specific rules regarding estimated tax payments are fairly complex. Before you take any specific action, be sure to consult with your tax professional.