Employees usually have tax withheld from every paycheck. Self-employed people and many business owners do not. Instead, the tax system expects them to pay as they go through estimated tax payments. Understanding how this works helps you avoid surprises and penalties.
What estimated tax is
The IRS page on estimated taxes explains that estimated tax is the method used to pay tax on income that is not subject to withholding. This includes earnings from self-employment, interest, dividends, rents and other income. Because the U.S. income tax is pay-as-you-go, you must pay the tax as you earn or receive income during the year, either through withholding or estimated payments.
Who generally needs to pay
The IRS explains that sole proprietors, partners and S corporation shareholders generally have to make estimated payments if they expect to owe tax above a set amount when they file. Corporations generally have their own estimated tax requirements. The exact thresholds are on the IRS page, and they can change, so check the current figures rather than relying on a number you heard a few years ago.
For self-employed people, estimated payments typically cover both income tax and self-employment tax. The IRS Publication 334, Tax Guide for Small Business, explains self-employment tax and how it relates to sole proprietors.
How the payment periods work
The IRS divides the year into payment periods, each with its own due date. If a due date falls on a weekend or legal holiday, the payment is generally due the next business day. Look up the current dates on the IRS estimated taxes page and put all of them on your calendar at the start of the year.
Paying late, or paying too little, can result in a penalty even if you end up getting a refund when you file. The IRS page explains how the penalty works and the exceptions that may apply.
How to estimate what you owe
Estimating is easier when your books are current. A typical process looks like this:
- Start from your year-to-date profit, using up-to-date bookkeeping.
- Project the rest of the year based on your normal seasonality.
- Consider changes, such as a large equipment purchase or a new contract.
- Use the worksheet in the IRS estimated tax instructions or work with a tax professional to calculate the payment.
- Revisit the estimate each period. If income rises or falls significantly, adjust the next payment.
This is where bookkeeping and tax planning meet. If your books are three months behind, your estimate is a guess. Our bookkeeping services keep your profit figures current so estimates are based on real numbers.
How to pay
The IRS offers several ways to pay estimated tax, including online options. Keep confirmation of every payment with your tax records.
Setting money aside
Many owners find it helpful to move a percentage of every deposit into a separate savings account reserved for taxes. The right percentage depends on your situation, so work it out with your tax professional. The habit matters more than the exact number: when the payment is due, the money is already there.
Choosing a business structure affects this too
How your business is organized affects how it is taxed and which estimated tax rules apply. Our guide to business structures and taxes gives an overview.
Get help planning
Our tax services help business owners stay organized for filing season, and our bookkeeping keeps the numbers current. Book a free consultation to talk about your situation.
