Don’t Forget Estimated Tax Payments
We often get asked why a client should make estimated payments and frankly when interest rates were close to zero we really didn’t push back when clients decided to not pay them. However, now that the IRS is charging 8% interest on late payments it is in the best interest of most clients to pay these on time.
What Are Estimated Tax Payments?
Estimated tax payments are used to ensure that you pay your taxes throughout the year instead of only at year end. They are required when you are not having enough income tax withheld from your income to cover your tax bill. This typically happens for business owners as they have business income with no withholding unlike someone who only has W2 income and their taxes are withheld from it. When withholding is not present, the IRS doesn't just sit back and wait for annual returns to be filed. Instead, it expects these taxes to be paid as the income is earned or received during the year.
How Much Should I Pay In Estimated Taxes
Estimated taxes are supposed to equal 90% of the current year tax or 110% of your prior year tax (you only need to do 100% if your adjusted gross income is under $150k). When making your quarterly estimate you should calculate your annual amount and divide it by 4. If your business is growing you can base these off of the safe harbor amount of 110% of your prior year tax but you will want to make sure to calculate the actual amount and keep the difference in reserve so you have it to pay the difference come tax filing time.
What Happens if You Skip Estimated Tax Payments
If you don't make your estimated tax payments a couple of things will happen. You could end up with a big tax bill when it's time to file your taxes because you haven't been paying taxes on this income throughout the year. Plus, the IRS might tack on extra penalties and interest for not paying as you go, making that bill even bigger. Currently, the IRS is charging 8% interest on these late payments but that is subject to change throughout the year.
When Should I Not Pay My Estimated Taxes?
While we almost always recommend paying your estimated taxes there are a few times we consider not making them or adjusting them. The first of these is when you owe taxes for a prior year. In this case, we always recommend paying down your outstanding balance before paying on the current year's estimated taxes. The second of these is when cash flow simply does not allow it. When this situation happens, we recommend taking action immediately to correct your cash flow issues and make sure the business is on solid footing so you can pay the tax bill when it comes due. People delay them for a variety of other reasons and in some cases it does make sense but each of these should be a specific conversation with us as your advisor before you make those decisions.
The Bottom Line
Keeping up with your estimated tax payments is crucial to avoid a big tax bill and penalties down the line. If you are second guessing your estimated taxes please reach out to us so we can help you understand your tax obligations and avoid any nasty surprises from the IRS. This way, you can focus on what matters most without the added stress of tax issues.
Don’t forget Q1 estimated taxes are due April 15, 2024.