While April 15 is the only tax deadline that most Americans know, small businesses – including sole proprietors, partners, independent contractors, LLCs and S corporation shareholders – face year-round tax deadlines. And if you’re new to self employment or business ownership, there’s a lot you need to know – and quickly – about estimated taxes.
“Estimated tax” is the method used to pay tax on income that’s not subject to withholding. When you earn a paycheck from somebody else, they take out your income taxes and send them to the government. When you work for yourself, that task becomes yours.
Your estimated tax payments, due quarterly, cover self-employment tax as well as income tax that you expect to owe for the year. “Self-employment taxes” are the Social Security and Medicare taxes you must still pay when you work for yourself. Employers normally pay half of this. But since you are both employer and employee, you must pay it all. (Income from S corporations is not subject to the self-employment tax.)
The total self-employment tax rate is 15.3 percent (12.4 percent for Social Security and 2.9 percent for Medicare), so it’s a big bite. Maximum earnings subject to Social Security tax in 2007 are $97,500. There’s no limit on the amount of wages subject to Medicare.
Federal estimated tax payments are filed with Form 1040-ES. The first payment is due April 15, and the others mid-month in June, September and January of the following year.
The rules dictating who must pay estimated taxes and how much you are required to send are frustratingly complex. Basically, the IRS says that if you expect to owe at least $1,000 in taxes this year, you must pay estimates. You are exempt, however, if your tax bill for last year was zero.
If you miss payments, or pay less than you owe, the government will charge you interest until you catch up. And anything still due beyond next year’s filing deadline will be charged a penalty as well.
Remember that if you have other income subject to withholding, that counts toward the taxes you ultimately owe and can be used to reduce your estimated payments.
These resources can help you learn more:
• IRS Publication 505, “Tax Withholding and Estimated Tax,” has all of the details on how this works. Find it at www.irs.gov/smallbiz.
• TurboTax Estimated Taxes is a nifty new service from Intuit that can easily calculate and file your quarterly estimated taxes. It costs $29.95 per year, including quarterly e-filings. Visit turbotax.intuit.com for details.
Daniel Kehrer can be reached at editor@business.com.
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