5 Questions New Business Owners Need to Ask About Estimated Taxes
Transitioning from being a full-time employee to an entrepreneur means approaching the way you do taxes differently. For anyone who is new to being self-employed (from a sole proprietor to a part-time business owner), your tax obligations now include filing an annual return and paying an estimated quarterly tax.
What is this tax and how often do you have to pay it, anyway? Here’s what first-time entrepreneurs need to know about their quarterly estimated taxes.
1. What’s the difference between estimated tax and self-employment tax?
Before we go any further, it’s a good idea to define what both of these taxes are and why they matter for self-employed workers, as well as whether or not you need to make a payment.
Estimated taxes. According to the IRS, estimated tax payments are made on income that is not subject to withholding tax. This can include your self-employment income or income like interest, dividends, business earnings, or capital gains, to name a few. While many entrepreneurs often forget to make these payments, it’s important to pay estimated taxes since these taxes pay income tax, self-employment tax, and alternative minimum tax.
Self-employment taxes: Abbreviated as “SE tax,” this covers Social Security and Medicare taxes for self-employed workers, just as these taxes would be withheld from the pay of a regular full-time employee. In order to figure out what you need to pay for this tax, you will need to subtract your business expenses from your business income; this will determine either your net profit or net loss. For a net profit, your expenses need to be less than your income; for a net loss, your expenses are more than your income. For any self-employment earnings that are $400 or more, you will also need to file an income tax return.
2. When do I have to make estimated tax payments?
This all goes back to the tax name: quarterly. Usually, these payments are made in four equal installments. If you make the payments in unequal amounts, note the amount of each payment to keep from underpaying or overpaying the IRS. Overpayments will result in a tax refund while underpayments will mean writing a bigger check to the IRS when you file your tax return.
What happens if you don’t make a payment? Whether you accidentally forget to pay, make the payment late, or don’t pay enough tax, you may be charged a penalty.
3. What forms do I use to pay estimated tax?
You’ll only use one form to calculate and pay your estimated tax: Form 1040-ES (Estimated Tax for Individuals). Keep your previous year’s tax return handy before filling out the form. On this form, you will have to compile your income, deductions, credits, and paid taxes in order to figure out what your estimated tax payment will look like.
Entrepreneurs filling out this form for the first time will have to estimate the amount of income they expect to earn for the year. Payments can be made either electronically through the Electronic Federal Tax Payment System (EFTPS) or through the mail using the blank vouchers included with Form 1040-ES.
4. Are my payments due on a specific date?
Yes! According to the IRS, quarterly estimated taxes are due within four payment periods:
- January 1-March 31
- April 1-May 31
- June 1-August 31
- September 1-December 31
- Deadline: January 15 (of the following year)
5. Is it possible to be self-employed and not pay estimated tax?
There are only a few exceptions to this rule. It’s not necessary to pay estimated tax if you’ve had no tax liability for the prior year, were a U.S. citizen for the whole year, and/or your prior tax year covered a 12-month period.