Solopreneurs, it’s essential to come up with planning and strategies for paying estimated taxes — if you decide to pay them at all. There is much to know about taxes. We decided to create a series of articles on the subject so that you can better understand them.
In Part One, we point out the various types of taxes and a high level of how and when they are assessed and due. In Part Three, we will go over how to set up a payment plan (again, if you decide to pay). We don’t want to get into each and every step of paying all taxes that may apply to you. We do fortunately have some great guidelines that will help you decode all the tax and compliance commotion. This article will also help you develop a system to cut through it all and pay these as timely and as accurately as you can.
As a reminder, almost all taxes you may be on the hook for fall into the following categories:
- 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
Below we discuss how much to pay, how to use payroll to your benefit, and a note on sales tax.
How much to pay
The reality of it is, much of tax planning is in estimating what to put aside and remitting the bare minimum taxes to avoid tax penalties and interest. The majority of our tax planning services go into saving you money and helping you adopt sophisticated Warren-Buffet-level strategies.
We find that the actual penalties and interest charges for missing tax estimates are very low. As such we often focus on optimal cash flow planning. However, those who want to pay quarterly (which often works well for conservative budgeters) can benefit from something called “ safe harbor.”
Safe harbor can mean protection from a penalty under certain conditions. You can use the concept of safe harbor when thinking about your estimated taxes. It will give you some leeway in terms of how much you need to pay. If you meet those specific conditions, your penalty can be waived or at the very least, reduced.
The safe harbor rule means you don’t receive an underpayment penalty if:
- You pay at least 90% of the tax you owe for the current year
- You pay 100% of the tax you owed for the previous year — this number increases to 110% if you make over $150,000 per year ($75,000 if you are married filing single).
- You owe less than $1,000 in taxes after subtracting your withholdings and credits
You have to pay in quarterly “installments.” If you are late or low there may incur some interest. There is another major workaround that most of our clients can use. You can use payroll to remit taxes. The rules apply but if you withhold taxes on your payroll (the W2 payments you make and record to yourself) the timing is irrelevant. For instance, you can run one payroll on December 31st, 20xx, and withhold the full amount needed instead of doing it in quarterly installments. No interest or penalties will apply.
(Also note: If your business is in its first year, or had a loss in the prior year, your estimated tax requirements in the current year, based on a safe harbor of 100% of last year would be zero.)
How to pay estimated taxes if you run payroll
If you use a payroll system like Gusto, ADP, or Paychex, you can configure bi-weekly payroll to both estimate and transmit timely to potentially all tax boards — with the exception of sales tax. This method will require a bit of work on your end. Or you can task a trusty accountant with the job.
We use this method for both ourselves and our clients. Again, you do need to dedicate a bit of time to set up various accounts and ID numbers. After running payroll the first few times you will find comfort in the time and money that you invested in payroll.
Payroll taxes are on the all-familiar W2 pay stub — that money that you likely hate to see taken away from your overall pay. One of the upsides of self-employment is that you can better understand and control where and when this money is removed from your bottom line.
Solopreneurs have options to defer payroll tax withholdings in a tax crunch. There is a big advantage to doing this on your payroll which deserves a future article. For now, we’ll leave you with this: if you use payroll withholding to capture and transmit taxes going to income and corporate tax, in general, there are no penalties or interest applied.
Because of this, many owners choose to run quarterly, or even a single payroll run for the entire year. You can also run a “bonus payroll” to withhold the thousands in taxes you may owe around December 31 of the given year. For all intents and purposes, the tax board treats this as money withheld on the first of the year.
What to do if you don’t run payroll
We do work with some folks who have tried to “figure it out” on their own. They pay as many as four separate tax agencies through their mini online portals or mail-in vouchers. For example, someone who lives in New York City may choose to pay via online ACH, mail-in checks, or a combination of both. They pay the IRS, the state income tax board, the New York City tax board, and the New Your Department of Taxation and Finance.
It’s a lot of work. You have to remember to pay and determine the correct amount to pay, as well as set up four different payment methods. As you can imagine it can be a lot for any solopreneur to keep track of. That’s why we generally suggest setting up your payroll instead.
A note on sales tax
Sales tax is relevant to you only if you take possession of actual merchandise and resell it. Determining how to do it and where to report and send sales tax payments is dependent on the cities where you store, source, and deliver goods. Generally, the customers we serve do not pay a material amount of sales tax in a year. That said, they do make periodic payments to different counties and possibly cities or states
We do recommend that you research the concept of the sales tax nexus if you want to understand sales tax. It’s a way of simplifying sales tax for growing companies. Sales tax nexus is the connection between a taxing jurisdiction (the state) and an entity (your business). Once you create this connection, you may be required to register, collect, and then remit sales tax to the state. Sales tax is triggered when your business meets certain thresholds and therefore establishes nexus with the state.
If your business is built around resale and you owe thousands per year in sales tax, we recommend Avalara. It is considered the gold standard for “sales tax as a service.” It features integrations with Quickbooks and other plug-ins for small businesses. We have worked with billion-dollar businesses in the past that use it. You can also look at other plug-ins for your accounting software. Materials planning or inventory software or Stripe and other payment portals to see what options may be cost-effective for you.
On the flip side, you, like many of our customers, may be able to solve any sales tax issues with basic features in Quickbooks, Xero, or even Excel. You’ll have to be able to identify your sales and source processes first. Then, simplify them around the concept of nexus. Limit transactions that bring in additional complexity such as drop-shipping or changing delivery options that let you sell out of one country in order to determine exactly what you owe. We at SoloSherpa are happy to discuss sales tax solutions with all our customers.
Stay tuned for Part Three on payment plans!
If you want more help understanding estimated taxes and how to pay them, please contact us for a consultation! We’re here for you.