Enjoy the Christmas and New Year’s holidays while they last because the new tax season will begin immediately afterward. Small business owners have to face numerous tax deadlines throughout each tax year or risk paying severe penalties and fees.
The Internal Revenue System (IRS) doesn’t play around when it comes to getting their tax money. That is why you need to understand how to calculate and pay the estimated taxes of your business to avoid paying late fees and other penalties.
When to Pay Taxes
The IRS wants business owners to pay taxes through a “pay as you go” tax system, which is when you pay taxes on the income you have just earned. It is not a legal requirement to pay the taxes immediately, but it is what the IRS prefers you do. That will definitely put you in good standing with the IRS if you comply.
Your W-2 employees don’t need to worry as much about tax day because you already withhold state, federal, social security, and medicare taxes from their paychecks. There are no estimated taxes they need to pay because they don’t usually pay any taxes during the tax season. In fact, they may get a tax refund on the taxes you withheld from their paychecks.
Therefore, employees love the tax season because they get money back from the government. On the other hand, business owners despise the tax season because it means they have to pay taxes. But their tax season is at least four times a year since business owners are expected to pay quarterly taxes rather than yearly.
Quarterly Tax Payments
Small business owners face a significant burden when calculating and paying taxes on their income. They can either pay their taxes monthly or send their tax payments at least four times each year to reduce the burden of paying monthly. Since you probably don’t want to have to deal with paying taxes every month, it would be easier to submit four payments yearly.
The standard payment schedule for small business owners is as follows:
- The first tax payment is due on April 15th for income earned between January 1st and March 31st.
- The second tax payment is due on June 15th for income earned between April 1st and May 31st.
- The third tax payment is due on September 15th for income earned between June 1st and August 31st.
- The fourth tax payment is due on January 15th for income earned between September 1st and December 31st of the previous year.
Each quarterly payment is based on the estimated taxes you have calculated for your annual profits. When you file your taxes with the IRS, your business may be entitled to a tax refund if you overpaid on your estimated taxes. But rather than receiving your tax refund back from the IRS, you can apply it to the next tax payment for the first quarter.
Your estimated income taxes are calculated by subtracting your company’s projected expenses from its predicted revenue, which gives you its predicted profit. Your total estimated taxes will include both your estimated income taxes and self-employment taxes added together.
Yes, don’t forget about estimating your self-employment taxes if you’re a sole proprietor because the IRS requires you to pay them too. Self-employment taxes contribute to your Social Security and Medicare benefits, so at least you’ll be getting this money back someday when you retire.
Employees pay for their Social Security and Medicare benefits through their payroll taxes. However, they only need to pay for half because employers are required to pay the other half for their employees.
As a result, you end up paying 100% of your Social Security and Medicare taxes if you’re a sole proprietor because you don’t have an employer paying 50% of those taxes for you. And if you’re a business owner who employs someone else, then you’re already paying 50% of their Social Security and Medicare taxes.
Aspiring entrepreneurs and new business people are usually encouraged to start sole proprietorships or limited liability companies because they supposedly have a lesser tax burden. However, you may find that forming an S-Corporation or C-Corporation could benefit your tax liability immensely because you won’t need to pay any self-employment taxes.
The IRS treats corporation owners as employees of the company. Because of this, corporation owners don’t have to pay self-employment taxes since they are technically working for another entity as its employees. The owners even fill out a W-2 form and get paid a salary or wage like any other employee.
Of course, you’ll still be responsible for paying commercial income taxes on the earned income of your business. But then you’ll only have to pay personal income taxes on the wages or salary you have paid to yourself by your company. Furthermore, you only pay Social Security and Medicare taxes on personal income, not commercial income. That is the most significant benefit of a corporation versus a sole proprietorship.
How Do I Pay My Estimated Income Taxes?
The IRS gives you two options for paying your estimated taxes without penalty:
- 100% payment on a tax amount based on last year’s tax total.
- Calculate this year’s estimated profit and taxes. Pay 90% or more on the total taxes you believe your company will owe.
Taking either of these actions will help your company avoid receiving unnecessary tax penalty fees from the IRS. For this reason, it is critical to understand your estimated taxes and make reasonable predictions about how much you will owe. Then you can stay on top of your tax bill by paying it before the IRS imposes any expensive fees.
Every business owner can execute the best strategy for managing their company’s estimated tax payments and saving as much money as possible. For instance, when your company experiences growth in its profit margin for the year, the best way to pay next year’s estimated taxes is to pay the same amount as you spent the previous year. Since you generated more taxable income, you should have more cash available to pay 100% of your estimated taxes for the new year based on the previous year’s total tax amount.
However, some companies won’t have enough cash reserves available to pay 100% of their estimated taxes. You’d often see this problem with newer companies or companies losing income rather than gaining income. If that’s the case with your business, then it wouldn’t be too beneficial to pay the tax amount of the previous year as your estimated taxes for the new year. Instead, try to predict how much you’ll have to pay in taxes by consulting with certified accountants and other financial professionals.