Welcome to the first episode of Small Business Focus with CK, where we explore practical topics to help entrepreneurs and self-employed individuals navigate the financial side of running a small business. In this episode, Tax Manager, Eric Challenger discusses the essentials of estimated taxes, including what they are, who needs to pay them, how to calculate them and when they’re due. Whether you’re a freelancer or a business owner, understanding estimated taxes can help you avoid penalties and better manage your cash flow throughout the year.

Transcript

Hi everyone and welcome to another edition of Small Business Focus with CK. I’m Eric Challenger, a tax manager here at CK and today’s focus topic is estimated taxes. Estimated taxes are payments made throughout the year to the government for income that is not already subject to automatic withholding. These payments help taxpayers avoid a large tax bill when they go to file their return. So who needs to pay them? As an employee, estimated tax payments are normally not needed. That’s because employers are required to withhold and remit taxes to the IRS on behalf of employee wages. Normally, this automatic withholding fulfills the burden of paying in taxes and eliminating the need for estimated tax payments. However, individuals that earn income not subject to withholding such as freelancers, self-employed persons, business owners, or others with income from investments, rental properties, or other sources will need to make estimated tax payments.

How are they calculated?

Estimated taxes are calculated based on projected current year taxable income. This requires understanding of your estimated income, deductions, and then applying related IRS tax tables to the estimated amount. You can use online calculators, tax software, or a tax professional to assist you with determining your estimated tax liability.

When are they due?

The IRS is a pay-as-you-go system. For wages, this means every check you earn will have your share of taxes withheld and then remitted by your employer. For all other taxpayers, the IRS requires that you make quarterly estimated tax payments based on the following schedule. First quarter, April 15^th, second quarter, June 15^th, third quarter, September 15^th, and fourth quarter, January 15^th of the following year. Any remaining balance must be paid by the return filing deadline of April 15^th of the following year. Although you may extend the filing date of your return, you cannot extend the payment due date.

Are there penalties for not paying timely estimated taxes?

Yes, as we stated before, the IRS is a pay-as-you-go system, and you must pay in taxes quarterly if you do not have any other withholding mechanism. Failure to pay your taxes timely will result in the IRS charging you underpayment penalties. This is really just another form of interest on the underpaid balance. This is applied at the current IRS interest rate multiplied by the number of days late. In addition, if you fail to make any payment by the filing deadline or fail to file your return timely, you may also be subject to late payment penalty and failure to file penalty. Each have a maximum penalty of an additional 25% of the unpaid balance due.

Are there any exceptions to avoid the underpayment penalties?

Yes. The IRS understands that tracking your current and your income in related taxes isn’t always easy or an exact science, especially for small taxpayers. To help ease this burden, the IRS has a safe harbor policy. Under the safe harbor, you have two ways to meet the exception for being assessed underpayment penalties. There are as follows. Number one, the current year safe harbor exception. If you pay in at least 90% of your current year tax and make the remaining 10% by the filing deadline of April 15th, then you will avoid underpayment penalty. However, this requires accurate tracking of your current year income and tax. This may be hard to do if you’re not a tax expert. Number two, the prior year safe harbor exception. The IRS will not assess underpayment penalties for taxpayers that paid 100% of their prior tax. For taxpayers with prior year adjusted gross income, AGI, greater than $150,000, this amount needs to be 110% of your prior tax.

Which safe harbor rule is the best to use?

Well, in years of rising income, it’s best to use the prior year rule to ensure that you at least meet the prior year test. Any remaining amount due will not be penalized if you pay by the filing deadline of April 15^th. In years of declining income, it’s best to use the 90% of the current year income, although this requires additional planning and accurate calculations. In most cases, it is better than overpaying the government and reducing your working capital or cash flow.

In summary, estimated taxes are designed to spread out to tax burden over the year. They apply mainly to self-employed individuals or people with income not subject to withholding. By making quarterly estimated tax payments based on your income, you can avoid underpayment penalties and manage your taxes more effectively. This has been another edition of the CK Small business focus. We hope our discussion on estimated taxes has given you some guidance you can implement in your tax planning for next year. For additional knowledge and understanding please visit our website at www.craykaiser .com.