When you’re self-employed, you’re periodically responsible to pay for a little thing called estimated taxes. There’s a lot of ground to cover, so we’ve decided to make this into a three-part series. Part One? A general overview of estimated taxes.
We’ve touched a lot on taxes here on the blog — it makes sense, we’re CPAs at heart and so taxes are a big part of our day-to-day lives. You can find more information about the seven different types of taxes that you should know about, and we have two different articles about taxes when you’re self-employed which you can read here and here.
If you’re an employee somewhere, you’ve likely never heard about estimated taxes. And, unless you plan to start your own business one day, you’ll likely never have to worry about them. But, one of the reasons why we wanted to share this important information is that many self-employed people and solopreneurs have never heard of estimated taxes either. If you find yourself in that boat, read on.
A quick recap on the different types of taxes
Quiz time: do you remember the most important types of taxes? If you don’t, here they are:
- IRS Federal Income Taxes
- State Taxes
- Corporate Taxes (LLCs and incorporations)
- Payroll taxes aka self-employment or FICA tax
- Sales tax and local city or municipal taxes
Remember: everyone is required to pay IRS taxes, even if you’re self-employed. This money typically goes towards maintaining infrastructure, social programs, and emergency disaster relief programs.
State taxes will (of course) vary from state to state. However, most include sales tax, state income tax, fuel tax, and property tax. There are a few lucky states out there that don’t have an income tax. You can find a list here. Sales tax and local city and municipal taxes also change from place to place.
As you can imagine, corporate taxes are required for LLCs and incorporations. And, if you have employees, you’ll be required to pay payroll taxes too. You’ll also have to pay it when you’re self-employed — in fact, it’s included in the self-employment tax (we talk a lot about it in the linked articles in the intro if you’re interested).
Now that we’ve covered the basics, let’s move on to estimated tax.
What are estimated taxes?
According to the IRS official website, estimated tax is “the method used to pay tax on income that is not subject to withholding. This income includes earnings from self-employment, interest, dividends, rents, and alimony. Taxpayers who do not choose to have taxes withheld from other taxable income should also make estimated tax payments.”
In other words, estimated taxes must be paid as you earn income throughout the year. Again, if you’re an employee you typically don’t have to worry about it. Taxes are automatically withdrawn from your paycheck so that you only really need to think about it once a year, during tax season.
If you’re self-employed or receive things like dividends, alimony, or capital gains, you are responsible for identifying and tracking these incomes. You will generally need to make estimated tax payments on them so the IRS doesn’t have to wait a month or a year to collect the taxes owed. If you’re a solopreneur, in particular, estimated tax includes income tax and self-employment tax.
How are estimated taxes calculated?
Estimated taxes are calculated on December 31st of the given year and are based on the taxable income, credits, and the like on your 1040 or corporate tax returns. While even a CPA might not be able to perfectly identify your eventual tax burden, the IRS is looking for you to pay at least 90% of the tax you will owe for the year by the last payment date (Jan 15th as described below).
Interest is applied from December 31st to April 15th of the next given year — sometimes 12/31 to 3/15 for some corporate returns.
In some cases, additional penalties are applied if not enough estimated taxes were made. It may even be the case that if the taxes aren’t paid congruently within each of the 4 periods listed below, you may have pro-rated interest or penalties applied.
If you’ve been paying attention, you’ll notice that you may have three different areas in which you need to pay: corporate, state, and federal. And, if you live in New York City, for example, you also need to pay local city taxes. Lastly, (again, depending on the state you live in and the nature of your business) you may also have to pay sales taxes. That’s five sets of estimated taxes to pay separately!
When are estimated taxes due?
Estimated taxes for personal and corporate taxes are due:
- April 15
- June 15
- September 15
- January 15 (the following year)
If the due date falls on a weekend or holiday, the payment is due the next business day. If you look closely, you can see that your payments are due from the beginning of the year at 3,2,3, and 4-month intervals.
At this point, you should understand what estimated taxes are, how they’re calculated, and when you’re required to pay them. In Part Two of this series, we’ll cover planning and strategies for paying them. Stay tuned!