October 31, 2023 | 7 minute read
One of the biggest surprises for new business owners often comes in the April after the first year of operations. Upon filing a tax return for the business for the first time, they discover that they owe a hefty tax bill. The reason: a failure to pay estimated taxes quarterly for the year before.
Planning, estimating and paying taxes as a business owner isn’t like being an employee. Generally, employers withhold taxes from their employee’s paycheck all year based on the amount the employee is expected to owe. When the employee files in April, they generally pay any remaining tax liability if their withholdings were too low or receive a refund if the amount withheld was too high. Business owners, in contrast, generally have to pay estimated taxes after the end of each quarter, typically based on what they made or estimated they would make during that three-month stretch.
Missing these quarterly deadlines can prove costly, and the penalties and interest for not paying estimated taxes on time become more severe the more the business owner owes and the longer they go without paying.
There are two approaches to calculating quarterly estimated tax payments:
If a business owner makes estimates based on the whole year, it is possible they will overpay or underpay on their quarterly payments. However, they can generally correct any overestimation or underestimation in the next quarter’s payment.
If a business owner calculates what they owe each quarter, their payments will be more accurate. However, this will require the business owner to give more time and attention to their taxes throughout the year.
A business’s structure will determine what taxes must be paid. For example, federal quarterly estimated taxes for a sole proprietor or business owner operating through an LLC will generally include self-employment tax. If the business operates as a C corporation or an LLC taxed as a C corporation, and the business owner is also employed by the C corporation or LLC, the business owner would generally not pay a self-employment tax on the salary they pull from the business in a year, but would generally pay only the employee portion of Social Security and Medicare taxes (the business generally pays the employer share). For information on how much a business owner would likely owe in self-employment tax, see the IRS Self Employment Tax guide. If the business has employees, the business may also owe payroll taxes, which include Social Security, Medicare taxes and federal unemployment taxes, for those employees.
Paying federal estimated taxes is just the beginning. A business owner may need to pay quarterly estimated taxes in one or more states. The types of taxes a business owner may owe include state and local income or franchise taxes, sales and use taxes, and gross receipt taxes, as well as employment taxes if the business has employees.
Estimated quarterly tax calculations for any state and local income taxes owed by a business owner hinge on several factors, including where the business operates, whether the state levies an income or franchise tax and how the business is structured. When a business operates in multiple states, for example, it or its owners may owe estimated taxes in each of those states. If the business is headquartered and only operates in one state — its inventory is stored there, all of its employees work in the state, all of its customers and sales are in the state, and the business owner spends all of their time there — the business owner may not need to worry about filing in multiple states. But if the business’s inventory is located in another state, it has employees in different states or it conducts business out of state, filing in multiple states may be required. Consult a tax professional for guidance specific to your business’s situation.
To get the best estimate of your taxes, consider arming yourself with helpful tools. This includes accounting software, such as QuickBooks1 that allows you to track the income you bring in each quarter and get insights on expenses that are potentially deductible. There are a number of different accounting software providers, each offering different capabilities and levels of sophistication. Ask other small business owners in your industry for recommendations and make sure to take advantage of free trials to gauge your comfort with using a software application before you sign up for it. Also look into apps that help you keep track of your revenue and profits and offer reports on how much you may owe in taxes for the quarter.
As a business grows and becomes more complicated — adding employees, expanding market presence or making capital investments, for example — a business owner may wish to consider hiring an accountant to handle tax preparation. An accountant can ensure a business owner is paying their taxes timely and accurately and also identify opportunities to optimize tax savings.
Five questions to consider asking an accountant before hiring them:
Once a business owner is ready to pay their federal quarterly estimated taxes, they can generally do so online or by mail. Many states offer an online option for paying state quarterly estimated taxes as well.
Tax deadlines come every quarter but are subject to change. When in doubt, check the IRS tax calendar and the applicable state department of taxation’s website. If tax payments are sent on time and to the right place, penalties and/or interest are less likely to accrue.
While the IRS encourages taxpayers to make accurate estimates of amounts owed, the agency does provide some leeway as long as quarterly estimated taxes are sent on time. For individual returns, there’s generally no underpayment penalty if the taxpayer owes less than $1,000 when they file their annual income tax return. Additionally, if the total of what was paid quarterly for the taxable year adds up to at least 90% of the total tax bill or at least 100% (110% for high-income taxpayers) of the previous year’s tax bill, the taxpayer is less likely to face a penalty.
Corporations with taxable income less than $1 million for each of the preceding three tax years generally are not subject to a penalty if their estimated tax payments are at least 100% of the lesser of the tax shown for the current or previous year. Corporations with taxable income exceeding $1 million for any of the preceding three tax years must generally make estimated tax payments equal to 100% of the current tax year.
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