One area new business owners may dread learning about is business taxes. Business owners have a number of different tax obligations, but not all of these taxes are levied against the business itself. Those who are considered self-employed usually do not have any Medicare or Social Security withheld from their pay, which means they always owe this money when they file their annual tax returns. In order to spread that cost out, the IRS requires self-employed individuals to pay estimated business taxes.
What are Self-Employed Estimated Taxes?
Estimated taxes are taxes a self-employed individual pays every quarter (three months). These taxes are based on the previous year’s revenue and should be enough to cover all Medicare, Social Security, and income tax. This way, the IRS and state both benefit from business owners paying in taxes at a semi-regular rate, and individuals can spread out their business taxes over the entire year instead of paying them in one lump sum with their tax returns.
Those who pay less estimated business taxes than they need to may face a penalty at the end of the year. Fortunately, because calculating estimated taxes isn’t an exact science, they don’t require self-employed individuals to pay the exact amount owed. As long as their estimated tax payments match the amount of tax they paid the previous year or cover at least 90 percent of their current amount owed, they won’t be penalized.
Who Has to Pay Estimated Business Taxes?
Anyone who is self-employed (contract workers, freelancers, temporary workers, etc.) and expects to owe at least $1,000 or more in taxes needs to make estimated payments. Business owners who set up their business as a corporation and expect to pay at least $500 on their annual taxes will need to make estimated payments.
Calculating Estimated Business Taxes
Determining estimated business taxes is done off of the previous year’s taxable income, adjusted gross income, credits, and deductions. This is a lot of information to analyze, which is why many new small business owners hire a CPA or other tax professional to help them calculate their estimated payments and other taxes. There are three different ways that an individual can use to determine how much they need to pay in business taxes.
The first is via the previous year’s tax return. Those who have paid in quarterly payments for several years will and have a business that is fairly stable will be able to use the previous year’s credits, deductions, and other information to get a fairly good idea of what their estimated payments will be. Of course, everyone hopes their business will continue to grow, which is why business owners are encouraged to pay a little bit more in business taxes than what they calculate to cover an increase in profits. This method may not be the best to use if a business is still growing because its income may be much more than the previous year’s.
The second method is by using a Form 1040-ES. This IRS tax form will walk business owners through the different calculations necessary to determine their estimated business taxes. It’s also the same from that they will use to file and pay these taxes. Note that those who own a corporation will need to use Form 1120-W instead.
The third method is perfect for those whose income fluctuates greatly. They can simply calculate their estimate of business taxes every quarter based off of their actual income. This does require recalculating every three months, though, but it does make the payments more manageable if the individual’s income has greatly dropped since the previous quarter.
When are Payments Made?
Estimated tax payments are done every three months using IRS Form 1040-ES. They may be mailed in or filed and paid online. The IRS will send those who have paid estimated business taxes before a set of payment vouchers every year with the due dates.
Paying Estimated State Business Taxes
Each state requires self-employed individuals to pay estimated state taxes. Information regarding how to make these payments can be found at the state’s tax office.
Work with a Tax Professional
For those who have never made estimated tax payments before, it’s important to understand how they work and how to calculate them. A CPA or other tax professional can provide more information, which will help you accurately calculate precisely what you owe in business taxes.