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Congratulations on starting your own business! Most likely you are experienced in your line of business and have done research to determine your business plan, how to get customers, how to price your products and services, etc. But have you thought about your taxes? If you were an employee before starting your own business, your taxes were probably pretty straight forward. Every paycheck had withholdings that added up (more or less) to the amount you would owe at year end, right? But now there is no paycheck – you must calculate and pay those withholdings yourself – ouch! You do this through quarterly estimated tax payments to the IRS and most states.
This article applies to sole proprietors and members of a partnership that are considered to be self-employed. The concepts are similar for S-corporations and C-Corporations but the specifics are different and not covered here.
When do I make estimated tax payments?
Estimated tax payments are due to the IRS on April 15th, June 16th, September 15th and January 15th, 2015.
You are expected to “pay as you go” so if your income is roughly equal each month, you need to make four equal payments or you may still be subject to a penalty even if you have paid the correct amount by the end of the year.
What IRS form do I need?
Use IRS Form 1040-ES - Estimated Tax for Individuals to estimate amounts and make payments.
How much do I need to pay?
The general IRS rule is …. You must prepay (through estimated tax payments)
100% of the total tax due on your 2013 return
90% of the total tax that will be due on your 2014 return
Whichever is smaller
** If your Adjusted Gross Income was more than $150,000 for 2013 (or $75,000 if your filing status for 2014 will be Married Filing Separately), then you need to substitute 110% for the 100% above.
(Note that there are different rules for farmers, fishermen. Also note that you don’t need to make estimated tax payments if you expect to owe less than $1000 in taxes or your total tax liability for last year was zero.)
The good news is that you already know what 100% of your tax was on your 2013 return so you can use that number and pay 25% of it each quarter. The possible bad news is that you make be making less this year as a new business owner than you were as an employee. If you can reasonably estimate the tax that will be due on your 2014 return, it may help you save a bit in estimated payments. You may want to meet with your tax professional to learn more about taxes for business owners. As an employee, your employer paid the employer portion of your taxes but as a business owner, you must pay both the employer and employee portion – these extra taxes are called self-employment taxes.
RELATED: 7 Tax Deductions for the Self-Employed
Business Owner AND Employee?
As a note, if you have just started your business this year but maintained your employee status at another company, you may be able to avoid estimated taxes (at least this year) because your withholdings will probably be close to 100% of last year’s tax. You should double check just to be sure. It doesn’t matter where the tax payments come from (employee or self-employment) as long as the total is correct.
In this very simple example, let’s assume that you anticipate your business profit to be about $50,000 in this first year.
Let’s also assume the following:
- This is your only income for the year 2014
- You are single with no dependents
- You will be taking the standard deduction
- You have no other deductions like retirement account contributions or education deductions
Your total income tax will be approximately $5,000 and your total self-employment tax will be approximately $7,100 for a total of $12,100 in total tax. If this is less than your total tax from your 2013 tax return then take 90% of this number (i.e. $10,890) and pay 25% of this amount (i.e. $2,723) each quarter. Remember to check your state guidelines as well.
RELATED: Understanding the Home Office Deduction
Here is a link to the IRS Self Employed Individuals Tax Center – from here you can get to the IRS Form 1040-ES and instructions. If you have a copy of last year’s tax return and you have estimated the business profit for this year, you can do the worksheets on Form 1040-ES and figure the correct amount to pay for estimated taxes.
A. Lynn Bertrand is an Enrolled Agent specializing in personal and small business taxes. She has her own tax practice and also volunteers to help low income tax payers prepare their returns. She could talk about taxes all day but realizes that most people like to hear as little about that topic as possible! Visit her website at www.taxtipsforlife.com for more short and sweet tax info or contact her at 516-558-7143.