Here's everything small business owners, freelancers, and other self-employed professionals need to know about filing quarterly taxes.
As we continue to navigate the fallout of the global pandemic, yet another tax quandary emerged from the murky depths: how do small business owners and independent contractors handle estimated quarterly tax payments when the future is still so unfocused?
The IRS extended the 2021 tax filing deadline to May 17 but initially did not officially push the quarterly installment date. After some uproar, the IRS announced that if you wait until May 17 to pay your estimated taxes, you won’t be subject to any interest or tax penalties.
Failing to meet installment obligations could result in an underpayment penalty — unless you meet specific safe-harbor criteria. So even though there will likely be a significant discrepancy between 2020 and 2021 income, the onus is on you to try to get it right.
However, even if you fall short initially, there’s no need to panic. The underpayment penalty won’t be significant as long as you catch up quickly. The federal government charges penalties of 3% annually, which doesn’t amount to a whole lot when you break it down—a quarter of one percent per month, to be precise. However, once it’s past due, the amount you owe starts accruing interest until it is paid in full. Past due payments will be charged interest at the federal short-term rate plus 3% – up to a maximum of 25% of the tax you owe.
Also, if you underestimate quarterly taxes, you might still be subject to a late payment penalty even if you overpaid on your last installment. The late-filing penalty is 5% of what you owe and is compounded monthly.
So, we’re going to do a deep-dive into quarterly estimated tax payments, who should make them, how to estimate what you owe, and ultimately, how to get it done without any undue stress.
Who should make quarterly estimated tax payments?
The Feds require all taxpayers to pay at least 90% of their taxes in one of two ways: either through tax withholding or by filing quarterly.
If you have income that is not subject to withholding, such as if you are a self-employed small business owner or have income from dividends, interest, business earnings, capital gains, or alimony, you’ll need to estimate your income and pay quarterly installments based on that amount.
If you fall into one of the following categories, you do not need to make installments:
- The tax you owe is less than $1,000 for the filing year after you subtract your federal withholding and tax credits from the total tax you expect to owe.
- Your federal withholding will be at least 90% of the total tax you’ll owe for the filing year.
- Your federal withholding covers 100% of what you paid in 2020. However, if your adjusted gross income for 2020 is $150,000 or more ($75,000 for married people filing separately), the safe harbor amount is 110%.
You are also exempt from paying estimated taxes if your tax liability was zero for the previous year or if you didn’t have to file a return because your income was below the threshold. However, even if this rule applies to you, you will still need to file if you have any income from self-employment.
The bottom line here? If you don’t fall into any of the above categories, you must make quarterly installments to the IRS. As for taxation at the state level, each state that has income tax has its own requirements and safe harbors, so check in with your state taxation office to find out what, if anything, has changed for 2021.
Why wait? Filing your taxes can take just minutes!
If you already keep excellent financial records and you have a reasonably good idea about what your income will be, filing your quarterly estimated taxes is a snap. Tax estimates will never be an exact science, but coming close is much better than falling short.
Form 1040-ES comes with a worksheet to help you determine your taxable income based on the current rules. Once you’ve completed the calculations, you can choose one of several payment options for what you owe, including through their mobile app, IRS2Go—which should be easy to remember because it sounds so oddly familiar, doesn’t it?
If you’re sending a check, keep in mind that the government won’t accept checks in amounts of $100 million or more. In that case, you’ll have to split the payment into two or more portions or arrange an electronic transfer (wink).
When to pay quarterly taxes
This year, the IRS did not extend the estimated tax filing deadline as it did for 2020. Still, it did extend the date to file your annual return to May 17, which, understandably, caused a lot of kerfuffle amongst tax professionals and taxpayers alike. Essentially, you were required to pay your first installment even if you had not filed your 2020 return. Kudos to you if you filed early and got it right—but if you didn’t, rest assured you’re not alone.
The estimated tax deadline dates for the 2021 calendar year are currently as follows:
- First Installment. For the period January 1 to March 31, 2021, the initial installment deadline is April 15. Since the annual filing deadline was pushed to May 17 this year, this understandably made the initial installments a little confusing. The IRS eliminated interest and penalties for late filing if the amount was paid by May 17.
- Second Installment. For the period covering April 1 to May 31, your second installment date is June 15.
- Third Installment. The third installment covers the period between June 1 and August 31, 2021, and is due on September 15, 2021.
- Fourth Installment. Your final installment covers September 1 to December 31, 2021, and is due January 18, 2022. However, if you file your 2021 return by January 31, 2022, and pay the whole amount due at that time, you do not have to meet the January 18 deadline and will not be penalized for missing that date.
How To Calculate Quarterly Estimated Taxes
Accurate projections go a long way to ensuring your estimated tax installments will also be correct. If you’ve been in business for a few years already, it’ll be easier to forecast, but it might be a little more challenging for new small business owners.
In simple terms, you calculate your tax owing for the year by taking your total tax liability and dividing it by four. Your total tax liability includes your self-employment tax, income tax, and any other taxes you generally pay.
Further complicating matters are various new rules and credits the IRS has recently enacted, but we’ll cover those a little further on in the article.
If you’re doing your tax estimates yourself—as opposed to having your accountant figure it out—the best way to do it is by getting the appropriate IRS estimated tax form and worksheet and following their detailed instructions.
First, you’ll have to figure out your projected income for the year. You start with your gross estimated income and subtract your adjustments.
Here is a list of some of the things you can deduct from the gross amount:
- Self-employed health insurance
- Health Savings Account contributions
- Retirement plan contributions
- IRA contributions
- Any penalties on early savings withdrawal
- Student loan interest to a maximum of $2,500
- Any alimony payments you made
- Moving expenses (armed forces members only)
If you do not itemize your deductions, you’ll take a standard deduction according to your filing status (married, single, etc.).
In general, the IRS suggests using your previous years’ federal tax return as a guide, but here’s where things might get a little complicated. If your business income changed significantly last year, such as if you were unable to work during the shutdowns and just recently started up again, using your 2020 tax return as a template might not be the best strategy. Ultimately, if you underestimate what you’ll owe this year, you’ll need to make it up by the time you file this year’s taxes, and nobody likes those kinds of surprises.
Conversely, if you overestimate your quarterly tax, you can recalculate based on what’s really going on when you go to file next quarter.
Keep in mind also, if your personal situation has changed—if you’ve gotten divorced, married, taken a second job, or if you get any other type of income that doesn’t withhold taxes—it could impact the amount of tax you owe. Additionally, any income you earn on side-hustle-type businesses, like Airbnb, renting out your ADU, or gig-economy-type jobs is all taxable, so you’ll need to take these into account as well.
If you have taken on any employment income, you might want to consider asking them to increase your withholding as this will reduce the amount you have to pay on installment.
How To Pay Estimated Quarterly Taxes as a self-employed professional
Now to everybody’s favorite part—paying the taxman. Okay, granted, most of us don’t enjoy paying estimated quarterly taxes, but you have to admit it’s a good feeling when you know it’s all over and done with. Right?
When you’re ready to pay, the IRS provides various payment methods by which you can settle up. Plus, if you overpaid for the 2020 tax year, you could credit that overpayment to your installment to reduce the amount owing.
You may also:
- Mail your payment by check or money order along with a payment voucher, found on page 11 of Form 1040-ES.
- Pay estimated taxes electronically with your bank card or credit card via the IRS website.
- If you use tax preparation software or with a tax firm, you have the additional option of paying quarterly taxes by electronic fund withdrawal. You can only use this option if you e-file.
- If you can’t pay the amount owed all at once, you can make an arrangement with the IRS to pay monthly installments against the balance. You can apply for a payment agreement online and will be notified immediately if you are accepted.
Alternatively, you can download the IRS2Go app, through which you can pay by card, manage your payment agreement, and get reminded when you have a filing deadline coming up. If you pay through the app, it is credited to your account instantly, and you won’t have to submit a payment voucher.
What If I Blow Off My Quarterly Taxes And Just Deal With It Later?
If you blow off your quarterly installment deadlines and payments, just know that you’re going to have to deal with it eventually. Unlike the ache of a bad breakup or a nasty sunburn, it’s not going to go away on its own.
Plus, the longer you wait to deal with your tax issues, the more the penalties will pile up. Depending on how much you owe and how quickly you pay it, that amount could end up being anywhere from a few hundred to a few thousand dollars – or more.
Nobody needs to be giving the IRS more than their due. That extra cash could come in handy for so many other useful things for your small business.
Some Tax Rules Have Changed Due To Coronavirus
Business and personal taxpayers would do well to explore any tax relief that they might be entitled to under the Coronavirus Relief Act. For example, if you were entitled to payments under the act but did not receive them, you may be able to deduct the amounts from your tax owing.
Employers and independent contractors can also apply for tax credits to cover amounts paid for sick and family leave, childcare, or employee retention. Be sure to understand everything you’re entitled to claim, as this could reduce your installment payments in a meaningful way.
If you need help finding out what coronavirus tax credits your business might be eligible for, speak to a business tax professional before it’s time to make your next installment.
Looking to ways to simplify your bookkeeping and managing your quarterly taxes? We’ve got your back.