It Is Time For Small Businesses To Make Estimated Tax Payments

Small business owners (and about 10% of nannies) know the dates April 15th, June 15th, September 15th, and January 15th all too well. Those are the dates when estimated taxes are due. If you run a business, you must pay the federal and state governments the taxes you estimate you owe for the previous period.

Well, September 15th is just a few days away (actually, since the 15th is a Sunday, estimated tax payments are due by Monday, September 16th this year), so it’s time to calculate and send in payments.

How To Calculate Estimated Tax Payments

I try and make the process as simple as possible by taking the highest tax bracket I’ll be in in a given year and multiplying that my net income for the last period. September’s payment covers June, July, and August, so if there was a combined income of $10,000 and I was in the 25% tax bracket, I wouldn’t just send in a $2,500 payment to the federal government, I’d tack on another 2.9% for Medicare taxes and an additional 12.4% for Social Security taxes. These taxes are fully covered by you since you are both the employer and the employee (typically, an employee pays half of it, 7.65%, while the employer pays the other half). Add it all up and it comes out to a whopping 40.3%! Wow, that’s a lot! The one break you get is that only the first $113,700 of income is subject to Social Security taxes, so if you have already reached that (congratulations), you can avoid that 12.4% tax for this round of estimated tax payments.

But wait, there’s more! You also have to make state estimated tax payments. In California, for couples, income over $74,010 is taxed at a rate of 8% and income over $93,352 is taxed at a 9.3% rate. In this example, let’s use the flat 8% rate to make things simple.

Tally it all up and you get 25% + 15.3% + 8% = 48.3%

While running a business sounds great, that’s a whole lot of the money you just earned going to state and federal taxes. And unlike as an employee where the taxes are taken out of your paycheck before you even see it, you’ve got to take that money out of your bank account and send it to the governments.

How Do You Make Estimated Tax Payments?

Each state has their own system, but the federal tax payment system just happens to be the easiest part of taxes. You simply enroll once, and then log in and make payments when they’re due. You can schedule payments and view your history. Just make sure to have enough money in your checking account when you schedule your payments!

What Happens if You Don’t Make Estimated Tax Payments?

Like with everything else, there are penalties for not paying your tax on time. You can avoid penalties in 3 ways:

  1. Owe less than $1,000 in tax at the end of the year
  2. Pay at least 90% of the tax for the current year
  3. Pay at least 100% of the amount you paid in taxes for the prior year

If you don’t fit one of these, you will likely owe additional tax at the end of the year. The penalty for underpayment of estimated tax is rather complicated, hopefully none of us have the need to use that document to calculate it for ourselves.

8 Responses to It Is Time For Small Businesses To Make Estimated Tax Payments

  1. Michelle says:

    Taxes are crazy. I never look forward to this!

  2. Crystal says:

    Wow, I forgot to mention state income taxes in my post today. Texas has sales taxes instead, so it’s easy to forget. Holy moly! We end up paying around 31% in taxes overall after deductions…

    • @Crystal, That’s at the highest rate, right? At the end of the year, I imagine your average tax rate is a far lower percentage of income.

      • Crystal says:

        @Daniel Packer, we made about $133,000 last year total (before deductions and whatnot, which brought us down to around $105,000), and paid about $32,000 total in taxes. So I guess our “actual” rate is around 25%. :-)

  3. Rob says:

    I understand that you are trying to keep the calculation simple. But using your top marginal tax rate to estimate your taxes would generally result in a large overpayment.

    For example, a married business owner with adjusted gross income (AGI) of $80,000 would have effective federal and state (California) income tax rates of 14.8% and 3.8%, respectively. If we add in 15.3% for payroll taxes, the total tax rate is 33.9% (or $27,133). Using your formula, this person would pay $38,640 in estimated taxes. That’s an overpayment of $11,507, 42% more than would be required.

    Unless you have massive swings in your deductions, the following formula (while still fairly simple) is much more accurate:

    1) 2012 AGI ÷ 2012 gross income x 2013 gross income = A (estimated 2013 AGI)
    2) 2012 total tax payments ÷ 2012 AGI = B (2012 effective tax rate)
    3) A x B = 2013 estimated taxes

    You would need to do this calculation separately for both federal and state taxes based on the prior year’s tax returns.

    Alternatively, if your gross income increased from the prior year, simply pay how much you paid in the prior year.

    • @Rob, Well if I make $80,000 as you say from my day job and this is just a side job (in my case, it is) then I am using the top tax rates.

      You are right that if you are running the business full time, you can use the marginal rates.

      • Rob says:

        The calculation I provided was for someone who earns their living solely as a business owner, not as a side job.

        In either case, using marginal/top tax rates will result in estimated tax payments that are far too high, whether or not it’s full-time or part-time income. Even if the calculation I provide above doesn’t work for a person’s particular situation, there has to be a better way. Perhaps someone else has another suggestion.

        Also noteworthy, most people have too much tax taken out of their paychecks and receive a refund at year’s end. If a person has a mix of employment and business income, this would further exacerbate the overpayment problem.

        Also, I believe you mistakenly said “marginal rates” rather than “effective tax rate” at the end of your comment. Your marginal rate is your top tax rate.

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