Jason Dinesen

Jason Dinesen

On Posted on by Jason Dinesen to Small Business Tax and Accounting

How to Calculate Estimated Tax Payments

Image courtesy of user TCB on Pixabay.com
Image courtesy of user TCB on Pixabay.com

A common question from business owners is, how and when do I make quarterly estimated tax payments?

There really are two things to consider with estimated payments:

  1. Do you need to make estimated payments at all, and
  2. How much do you need to pay?

Do You Need to Make Estimated Payments?

Estimated payments are required if:

  1. You will owe at least $1,000 on your tax return, and
  2. Your withholdings and refundable credits will be the lesser of A) 90% of your current-year tax liability, or B) 100% of the tax liability shown on your prior-year tax return (110% if your AGI is above certain levels)

How Much Should You Pay?

There are a couple of different ways to calculate how much your estimated payments should be.

  1. Take your prior-year tax liability (or 110% of your prior-year liability, if your AGI is above certain levels) and divide by 4. The result would be what you’d send to the IRS each quarter.
  2. Estimate your current-year liability and multiply by 90%, then divide by 4.
  3. Base your quarterly payments on your actual income for the quarter (useful if your income varies from quarter-to-quarter).

Each of these methods represent a minimum payment amount that will keep you from getting hit with a penalty on your tax return.

What If I Don’t Make Estimated Payments?

A common question people have is: why should I bother making estimated payments? Why not just keep the money in my pocket until I file the return?

There are two reasons why estimated payments are a good idea:

  1. As mentioned above, the three methods shown are like “safe harbors” where you avoid getting hit with an “estimated tax penalty”; even if you end up owing on your tax return, you won’t be subject to a penalty as long as you used one of the 3 methods above to send in estimated payments during the year.
  2. As I’ve written before, many people get into gigantic holes because they don’t make estimated tax payments. Some of my self-employed clients routinely owe $30,000 when we file their tax return, and sometimes much more than that — and they haven’t made estimated payments and they usually can’t pay it off all at once. So they get into payment plans. But then all of their payments to the IRS are going to cover the back taxes and nothing is being put toward the current-year liability. Meaning, at tax time next year, they’ve got the same problem and they fall further into the hole.

Further Reading

This post is a basic overview of estimated taxes and ways of calculating. For more in-depth reading, see IRS Publication 505.

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