As a business owner, your tax obligations aren’t just limited to tax season. Instead, you need to revisit your tax situation each quarter to make estimated tax payments. Knowing how much to pay the IRS can be confusing, especially as your income fluctuates throughout the year.
In this article, we’ll cover how to calculate and set up quarterly tax payments using your profit and loss statement, helping you streamline the process and eliminate stress. We’ll also cover other options for paying the IRS throughout the year and the details on which items impact your quarterly payments.
When Are Quarterly Tax Payments Required?
Quarterly tax payments help avoid fines and penalties when you file your individual income tax return. They are required if two conditions are met:
- You expect to owe at least $1,000 in tax during the current year. This is after subtracting withholding and refundable credits.
- You expect your withholding and refundable credits to be less than the smaller of:
- 90% of the tax due on your return in the current tax year
- 100% of the tax due on your return in the prior tax year (The percentage is adjusted to 110% if your adjusted gross income was above $150,000 for joint filers or $75,000 for single filers)
If you meet either of these conditions, you must remit quarterly tax payments throughout the year. Failure to submit the necessary quarterly tax payments can result in stiff fines and penalties when you file your tax return. Currently, the individual underpayment rate is 7% per quarter.
What Factors Influence Quarterly Tax Payments?
While your business income is a major factor that influences your quarterly tax payments, it isn’t the only item that needs to be considered. Quarterly tax payments are imposed on your overall tax liability, which can include income from other sources and applicable credits and deductions. Here are a few factors that can influence your quarterly estimates:
- Investment Income – Capital gains, interest income, and dividend income can increase your overall income, resulting in a higher estimated tax payment.
- Wage Income – Income from other employers, including your spouse’s income, can impact your estimates. Although W-2 income generally has tax withheld, any underpayment can result in a higher quarterly tax payment.
- Other Income – Prize income, unemployment income, rental income, other business income, and any other type of taxable income should be considered.
- Dependents – Any dependents that qualify for deductions, like childcare or the Child Tax Credit, can lower the amount of your estimated tax payment.
- Deductions – Deductions, like the Home Office Deduction or the Qualified Business Income Deduction, can reduce your income. Tax-specific items, like special depreciation options, can also lower your quarterly estimates.
- Tax Credits – Other credits, like the Lifetime Learning Credit or the Earned Income Tax Credit, have the ability to reduce your tax liability.
How to Calculate Quarterly Tax Payments Using Your P&L
Calculating quarterly tax payments can be confusing, especially if you have high and low commission months. Here is a three-step process to calculate quarterly tax payments using your P&L:
- Complete Accounting – First, you will need to ensure that your accounting records are accurate and up-to-date. Be sure that all reconciliations are complete and that you have everything recorded.
- Pull Quarterly Report – Next, pull your profit and loss statement for the last quarter. For example, pull January through March for the first quarter estimate due on April 15.
- Multiply by 30% – Now, take your Net Operating Income (the profit of the business before owner compensation), and multiply it by 30%. For example, if your Net Operating Income is $10,000, your estimated quarterly tax set-aside would be $3,000. In any quarter where this number is negative, no tax estimate is required.
This is a simplified approach to calculating quarterly estimates. Remember, this doesn’t take into account the other items on your return or if you are in a higher tax bracket. For example, if you are in the 37% bracket, you will likely be underpaid. This is why working with a tax accountant to put together a formal tax plan can be beneficial.
Other Options for Calculating and Paying Quarterly Tax Payments
Here are a few other options for calculating and paying your quarterly tax payments.
Payroll
Estimated tax payments are only necessary if you do not remit enough withholding throughout the year to cover your tax liability. This means that if your payroll withholding is high enough, you don’t need to make estimates. Increasing your federal tax withholding on your paycheck will result in a lower net pay, but it can streamline the process since you are likely already making federal tax payments. First, figure out how much extra withholding you need. Then, divide that amount by the number of payrolls you run each year to determine how much extra withholding you need to have.
Safe Harbor Rule
The Safe Harbor Rule says that you can pay 90% of your current year’s tax liability or 100% of your prior year’s tax liability (110% if your prior year’s AGI was over $150,000) and avoid underpayment penalties. Ensuring you follow these standards can help you avoid complicating your tax payments.
Let’s say your prior year tax liability was $10,000 and your AGI was under $150,000 as a joint filer. Assuming no additional withholding during the year, such as from payroll, you would submit quarterly estimates of $2,500. The downside to this approach is that it can leave you with a large tax bill at the end of the year if your income is higher.
Online Tools
Many accounting software programs have built-in tax estimators. For example, TurboTax TaxCaster, ADP MyTax, Keeper Tax, and H&R Block all have tools to help you determine how much to pay in each quarter. Investing in these items can be worthwhile if you don’t want to pay an accountant to put together a tax plan. However, these tools are just estimates and can be inaccurate, especially if you have other influential items on your return.
Summary
Figuring out how much you owe the IRS each quarter can be confusing. The first step in determining your payment is having an up-to-date and accurate profit and loss statement. Reach out today for help getting your accounting records caught up.