Running a business means keeping an eye on more than revenue and operating costs. Tax obligations also require planning, especially when income is not subject to regular paycheck withholding. For many business owners, that means paying taxes during the year rather than waiting until filing season.
If you anticipate owing at least $1,000 in federal tax after accounting for withholding and credits, you may have to make estimated tax payments. Planning ahead can help you avoid an unexpected balance when you file your return and may reduce the possibility of an underpayment penalty.
Income that may require estimated payments
Estimated taxes generally apply to taxable income for which taxes are not withheld as you receive it. Depending on your circumstances, this can include:
- Business or self-employment income
- Rental income
- Interest and dividends
- Capital gains and other investment income
For business owners, estimated payments can cover both federal income tax and self-employment tax. State or local tax obligations may apply as well. The IRS explains estimated tax requirements for self-employed individuals and business owners.
How to estimate what you owe
A practical starting point is your most recent tax return. Review your income, deductions, credits and total tax, then consider how your business and other income may change during the current year.
You may be able to use your previous year’s tax liability to help determine whether you are meeting a federal safe harbor. Higher-income taxpayers generally have a higher required percentage under these rules. Your filing status and income level can affect the calculation, so do not assume that last year’s payment amount will automatically be sufficient.
Your estimate may need to account for:
- Federal income tax
- Self-employment tax
- State and local taxes
- Available deductions and credits
- Tax already being withheld from other income
Adjusting payments when income changes
Business income does not always arrive evenly throughout the year. If your earnings are relatively steady, your estimated payments may be similar. But if you expect substantially higher income during particular months or quarters, an annualized approach may provide a better reflection of when you actually earn that income.
Review your projections regularly rather than setting an amount once and forgetting about it. A significant change in business income, deductions or other taxable income may warrant recalculating your remaining payments.
Estimated tax payments generally follow four annual due dates, although those dates do not necessarily correspond exactly to the traditional three-month calendar quarters.
Keeping organized records of income and payments can make this process easier. If you are unsure how much to pay or which safe-harbor method applies to you, a tax professional can help evaluate your circumstances and develop an appropriate payment strategy.
