Most interior design business owners are required to estimate taxes for the coming year. They then divide that total into four equal payments and submit one payment each quarter. The IRS designed estimated tax payments to help business owners budget. By making estimated tax payments, business owners no longer owe an enormous singular payment the following April. While making these quarterly payments can protect you from a tax bill you simply cannot afford, they can also be restrictive. This is especially common when business owners expect to make less money this year than they did the previous year. In this post, we answer all your frequently asked questions about quarterly estimated tax payments. We also explain how to ensure you only pay the estimated taxes you actually owe instead of overpaying.
Answering All Your FAQs About Quarterly Estimated Tax Payments
As we published this post in April, you have probably already filed your tax return for last year. Soon enough, your first quarterly estimated tax payment of the new year will come due! Let’s get into it.
Must I make estimated tax payments?
If you own a business and expect to owe more than $1,000 in taxes this year, you must make quarterly estimated tax payments. This applies to all types of business structures, including sole proprietorships, partnerships, LLCs, S corporations, and C corporations.
Calculating estimated corporate taxes is more complex than doing so as a sole proprietor or the owner of an LLC. Regardless of your business structure, it’s essential to stay on top of your estimated tax payments, as failure to do so can result in penalties from the IRS.
Will the IRS notify and refund me if I overpay?
The IRS will refund you if you overpay. However, the IRS will not notify you if you have either overpaid your estimated taxes, or withheld too much from your paychecks.
You and your tax preparer must request a refund after determining that you have overpaid your share. Alternatively, this resource from TurboTax notes that you can “have the overpayment apply to your future estimated taxes.”
When are estimated tax payments due for my business?
The due dates for estimated taxes fall on April 15th, June 15th, September 15th, and January 15th of the following year. Sometimes, due dates will extend to the 16th, 17th, or 18th of that month. Remember that failure to make these payments by their respective due dates will result in a penalty.
Which forms do I file?
Making estimated tax payments does not require you to file any forms. For most business owners, filing occurs once a year — either in April or October. The forms you will file come tax time differ depending on your business structure.
Use Form 1040-ES to calculate your estimated tax amount and ensure timely payment. Submit your payment through the Electronic Federal Tax Payment System (EFTPS) or mail a check. If you owe a penalty, you might also need Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts.
What are the underpayment penalties for estimated taxes?
If you underpay your estimated taxes, you might owe an underpayment fee. You might also be charged interest in addition to other fees. Individuals who pay at least 90% of the tax they owe rarely incur underpayment penalties or interest charges.
Calculating your unemployment penalty is not quite as cut-and-dry as you might imagine. In an article for Investopedia, Adam Hayes explains. Hayes notes that “the penalty is not a static percentage or flat dollar amount.”
Instead, your penalty is based on “the total underpayment amount and the period in which taxes were underpaid.” According to Hayes, underpayment failure to pay penalties are usually approximately “5% of the underpaid amount…capped at 25%” of your bill.
The interest you owe will depend on the IRS’ current rate. Last year’s interest rates were between 6 and 8%.
Can I avoid an underpayment penalty even if I owe one?
According to the IRS, business owners can escape these underpayment penalties under certain circumstances. For example, they can avoid the penalty if they “owe less than $1,000 in tax after subtracting their withholding and refundable credits.”
They can also avoid the penalty if the total tax paid was “at least 90% of the tax for the current year or 100% of…the prior year.” Business owners are required to match the smaller of those two numbers. Corporations are subject to slightly different standards.
If you do owe an underpayment penalty, the IRS will send a notice to your address. Business owners using tax preparation software or services like TurboTax or H&R Block should be prompted to pay the penalty before filing.
How do I calculate my estimated quarterly payments?
Most business owners base the current year’s quarterly tax payments on last year’s AGI. To calculate your quarterly payments for 2023, consult the IRS’ Estimated Tax Worksheet on Form 1040-ES or Form 1120-W. Individual taxpayers can use this sheet from the IRS.
As noted above, you will base estimated payments on your adjusted gross income. Your adjusted gross income is your total estimated income minus any deductions and half of your self-employment tax.
Next, calculate estimated income tax and self-employment tax. Add the two figures together and divide by four to determine the dollar amount of each quarterly payment.
If you already filed your 2022 tax return through a tax preparation service, your quarterly estimated tax payments for 2023 are probably already listed. You will either pay 90%, 100%, or 110% of last year’s estimated taxes. For further assistance, crunch the numbers with this estimated tax calculator from Bench.
What if my income has jumped YOY?
If you expect your income to increase significantly in 2023, you can still base your estimated payments on last year’s AGI. However, you will owe more in income and self-employment taxes next April. To avoid a penalty in addition to the remainder of your tax bill, the IRS recommends basing your estimated tax payments on 100% of this year’s income.
What if I expect to make less money this year?
On the other hand, you might make less money this year than you did last year. How can you avoid overpaying estimated taxes if you anticipate a dip in income?
You can either make estimated payments based on last year’s total tax liability and wait for a refund or adjust for this year’s income. If you can accurately estimate this year’s income, cover at least 90% of what you will owe in estimated payments.
Does my state require estimated quarterly payments too?
Most states that collect income tax from residents require business owners and freelancers to make estimated quarterly payments. However, the frequency, amount, and manner in which you remand these payments differ from one state to the next.
The thresholds are typically lower for state income tax than for federal income tax. For example, California requires business owners who will owe more than $500 to make estimated tax payments.
Just as many states require you to submit estimated taxes, so do they levy penalties and fees if you fail to pay. Consult your state government for more information.
Can I avoid making estimated payments?
Only those who receive a salary or wage can avoid making estimated payments, as their income and employment taxes are withheld. But what if your business is structured as an S-Corp or C-Corp, and you pay yourself a salary? If you pay yourself a salary that includes income tax withholding, estimated taxes are based on your firm’s profit for the year.
How to Limit Your Estimated Tax Liability as a Firm Owner
Select the right business structure to limit your income tax liability as a firm owner. After switching to a business structure that reduces how much you will owe, take advantage of tax deductions and credits.
Next, consult a tax preparer to ensure any event that impacted you or your business over the last year is taken into account before filing. In certain circumstances, you could reduce your estimated tax payments. For instance, if you experience a casualty or disaster that affects your income, you may qualify for a cut or delay in your estimated tax payments.
The opposite can also be true. Certain circumstances trigger an increase in your estimated bill. If you receive unemployment benefits or withdraw funds from a retirement account during the tax year, this could increase your taxable income and require additional estimated tax payments. Always be aware of how income stream changes might affect your quarterly estimates.
Regardless of your financial situation, pay estimated tax quarterly to ensure you do not owe an estimated tax penalty. File your tax return early to avoid any additional fees.