How Do I Calculate Estimated Taxes for My Business?
Lots of business owners get caught with tax surprises at startup or when they begin to make a profit. The surprise comes because they don't realize they must pay estimated taxes on their business income. This article describes how to do a quick general calculation to find out how much you might have to pay in estimated taxes.
The IRS has announced a three-month extension on paying and filing 2019 federal income tax returns, to July 15, 2020. This extension applies to all taxpayers, including businesses, and it also includes an extension on paying estimated taxes for 2020. Estimated tax payments for the first and second quarters of 2020, due April 15 and June 15, are now due on July 15.
Why Estimated Taxes are Important
You are probably a small business owner paying taxes as a sole proprietor, LLC owner, or partner. In these cases, you must pay your business income taxes through your personal tax return. This is called pass-through taxation.
Let's say you make a profit this year in your business. If you were an employee you would have payroll tax deductions for income taxes due on your income (business and personal). But as a business owner, you aren't an employee, so no taxes on your income from the business are taken out.
You are also required to pay Social Security and Medicare taxes on your business income. The combination of income taxes and Social Security/Medicare taxes on your business income is called self-employment taxes.Your payments to yourself as an owner are considered an owner's draw, not salary.
Paying Estimated Taxes to Avoid Penalties
Both income tax on and self-employment tax on your business income must be paid through your personal tax return. But you haven't withheld anything to pay them. This is where estimated taxes come in. You must pay quarterly estimated taxes to avoid penalties and interest on late payments.
Who Must Pay Estimated Taxes
When you consider whether you must pay estimated taxes, you'll need to look at all of your income for the tax year, including any income from employment (not as a business owner), capital gains, dividends,
The IRS says you don't have to pay estimated taxes if you meet all three of these conditions:
- You had no tax liability for the previous year,
- You were a U.S. citizen or resident for the entire year, and
- Your previous tax year was for a full 12 months.
You must pay estimated taxes if:
(a) You owe $1,000 or more for the year ($500 for corporations), over the amount of withholding from any salary as an employee or refundable credits, or
(b) Your total withholding and refundable credits are:
- Less than 90% of the tax shown on your current year's tax return, or
- Less than 100% of the tax shown on your previous year's tax return.
How Underpayment Penalties Work
If you don't pay enough through withholding and timely estimated tax payments, you may be charged a penalty. You may also be charged a penalty if your estimated tax payments are late, even if you got a refund.
How and When to Pay Estimated Taxes
Payments are due four times a year:
- 1st payment – April 15 (except for 2020 payments due July 15)
- 2nd payment – June 15 (except for 2020 payments due July 15)
- 3rd payment – September 15
- 4th payment – January 15 of the next year.
If your income is steady throughout the year, you can divide your payments up into four equal payments. If your business is seasonal or you have a change in your business income, you may have to make smaller or larger payments in one or more quarters.
You can use the quarterly vouchers included in IRS Form 1040-ES to make these payments.
If you use a tax preparer or tax preparation software to prepare your tax return, they will include an estimated tax calculation and copies of vouchers. You must make the payments yourself by
- Mailing in the payment with the voucher,
- Online using IRS Direct Pay, your credit or debit card, or one of the other IRS payment options, or
- By phone.
See IRS Form 1040-ES for copies of vouchers and details on these and other payment methods.
You can make additional estimated tax payments to make up for a quarter with more income, and you can also make your estimated payments weekly, bi-weekly, or monthly, as long as you have paid enough by the quarterly due date. It's easier to make these payments online, through one of the IRS-approved payment methods.
Information Needed for the Estimated Tax Calculation
To calculate estimated business taxes from Schedule C you will need to combine this business income with information on other income, tax withholding, deductions, and credits on your personal tax return. You will also need to calculate self-employment tax (Social Security/Medicare taxes for business owners) and include self-employment taxes in determining estimated taxes due.
When you estimate your taxes for the year, include all sources of income, including salary, tips, pension, dividends, alternative minimum tax, winnings, prizes and awards, interest, and capital gains, in addition to your business income and self-employment tax.
Here is a list of the information you will need:
- An estimate of your business income for the tax year. You can use your income from previous years, or take your income up to the current date and estimate income for the rest of the year.
- An estimate of business expenses for the year, using previous years as a guideline or using year-to-date expenses and projecting them through the end of the year.
- Because your estimated taxes depend on your personal tax situation, you will need to include personal income, deductions, credits, exemptions, and any withholding of federal income taxes from your personal income. In the same way as business income and expenses, you can use information from prior tax returns or use year-to-date and project to the end of the year.
Estimated Taxes – Some Calculation Methods
You can calculate your estimated tax payments by asking your tax preparer to run an estimate, by using the IRS estimated tax calculation worksheet, or by getting a rough estimate from your previous year's return prepared with tax software:
You can use the estimated tax calculation worksheet provided by the IRS on Form 1040-ES or using the worksheets included in Publication 505. Corporations usually use Form 1120-W to calculate their estimated tax.
Use tax preparation software to run a rough calculation of estimated taxes for the next year. If you use the same software every year, you can start with last year's return for information. The tax software includes self-employment taxes. If your business and personal income are fairly steady from year to year, it provides a rough estimate for tax planning purposes.
Be sure your tax preparation software is the small business or self-employed version. Before you buy, check to be sure it includes Schedule C and Schedule SE (for self-employment taxes). Business tax return versions are usually for a specific business type, like partnerships, corporations, and S corporations.
Estimated Taxes for Partnerships, LLC's, S Corporations
Owners of partnerships, LLCs, and S corporations are not employees of the business. They receive payments periodically from the business, and these payments are added to their personal tax returns.
These payments are not subject to withholding, so estimated taxes may need to be paid. To calculate estimated tax payments, use the process described above.
Disclaimer: This calculation and the information in this article is not intended to be tax advice. It's just a way to get a general idea of what might be due. Work with your tax professional to determine the amounts due on estimated taxes and when they are due.