From a business finance perspective, cash is always king. Especially as tax season enters the picture this year, the strongest pull for owners to get everything done is to see if they owe any more taxes (or if they get a refund). Said differently, we want to know when our cash must be used for taxes. If your tax planning is done correctly, there should be little, if any, cash needed come March or April. Instead, properly using the Quarterly Tax Payments can help you spread the cost of taxes for a business over a whole year, as opposed to one penalty-filled payment in the Spring.
Key Takeaways
- The IRS requires estimated quarterly tax payments from those earning over $1,000 from non-W-2 sources like self-employment, freelance work, or investment income, since these earnings don’t have automatic tax withholding. Failure to pay can result in IRS penalties and interest.
- Estimated tax payments should follow one of the two IRS Safe Harbor rules. One option is to pay 100% of last year’s tax (110% if income exceeded $150k annually), which works well for stable income, but may result in overpayment in down years. Alternatively, you could pay 90% of the current year’s expected tax liability, which requires more frequent income calculations but prevents overpayment if earnings decline.
- Proactive cash flow management for taxes is critical for business owners and high earners. The simplest approach is the 110% Safe Harbor rule with mid-year adjustments to Q3 and Q4 payments if income changes, so that you minimize year-end refunds or penalties.
Who Should Pay Quarterly Taxes
Generally, anyone with taxable income outside of a typical W-2 job would need to send in estimated payments. This could include retired people with investment income, self-employed and business owners, and those with side gigs or freelance work. Generally, in a W-2 job, the company’s payroll system will send tax dollars to the IRS on your behalf. All the other jobs that don’t have payroll, the tax due on income is still required; you just have to take the extra step roughly every quarter to send the IRS a check for your taxes.
If you make more than $1,000 in income, the typical taxes could apply. This could include federal income tax, payroll taxes, and possible state income taxes as well. For those who are self-employed, the self-employment tax could apply as well. Self-Employment taxes are essentially the same as the payroll taxes, where you are subject to Social Security and Medicare taxes.
The quarterly payments are set for the same days each year, assuming they do not fall on a weekend. April 15th, June 15th, September 15th, and January 15th of the following year are the 4 set days that payments are due. They are not perfectly spaced out, so there can be years when the June 15th payment date comes faster than you realize, given that both the April and June dates are in the same calendar quarter. Regardless, making estimated payments before these deadlines can help with IRS compliance. Not paying the estimated payments could result in penalties and interest. Virtually no one wants to voluntarily give the government extra interest and fees, yet many times it happens.
How Much Should I Pay?
Your estimated taxes should change from year to year, depending on how well your business and related income did for the previous year. Generally, your accountant should finish your returns for the previous year and set a rough amount for the 4 payments for the current year. While not even you or your accountant knows exactly how much income you will make this year, the IRS has defined rules to help taxpayers avoid penalties and interest. Known as the Safe Harbor limits, adopting one of these limits as your quarterly payment strategy could be a better bet.
The first safe harbor limit, and perhaps the safest, is to pay 100% of your previous year’s tax. If you made more than $150,000 in income last year, then you must technically pay 110%. This will help keep you from underpayment penalties. Over the 4 payments, you are at least keeping up with the full amount from last year. This strategy works great if your income is very similar to last year, and therefore, the true tax liability is probably about the same. However, for years where income is going to be down, this 100% or 110% strategy could cause you to overpay to the IRS (which is not the best move if profits are already down for the year).
The other Safe Harbor limit that the IRS permits is to pay throughout your quarterly payments, 90% of the current year’s tax liability. This strategy is meant to combat the drawback of paying 100% of last year’s, if the current year is a down year. However, calculating exactly what 90% of this year’s tax may be more difficult and involved. Especially for business owners with more variable income, it could be harder to guess exactly how much income will come in from month to month. This is when your accountant could step in and help ballpark exactly how much to pay each quarter to reach this 90% threshold.
Cash Management for Taxes
Having cash on hand to pay for taxes throughout the year is critical. Depending on your business, it is easily one of the largest expenses and largest checks that go out the door each year. Understanding which Safe Harbor limit to use can help make your cash management more proactive. There is a fine line between never sending the IRS more than required but also sending enough to avoid penalties and interest. For high-earners and business owners, taking 110% of last year’s tax and dividing by 4 is the easiest solution. Then, as September 15th and January 15th come around, you can ask your accountant to verify that the quarterly payments are on track.
If the year turns out to be a higher income year, then increasing the Q3 and Q4 quarterly payments can also help. Again, the goal is to optimize the four quarterly payments so there is virtually no refund or taxes owed once tax returns are filed. Getting to this point can provide you with more clarity around how to manage your cash flow. Knowing whether you are going to have to write a check to the IRS for $30,000, because your quarterly payments were low, is something I’d rather plan for ahead of time.
This also applies to other taxes, and perhaps most importantly, State Income Tax. For those who live in states with a state income tax, making state tax payments can be just as important as the federal payments. It is important to set a plan for state taxes, since the rules around quarterly payments may be different from state-to-state. Fortunately, there are additional strategies that could help with state income taxes, such as the PTET payments made by companies on the owner’s behalf.
Pay Your Taxes
At the end of the day, paying taxes is a normal part of business life, and one that cannot be ignored. The degree to which you are intentional about your quarterly tax payments will dictate how much a given strategy can benefit you. Simply knowing the Safe Harbor rules is a great start to help avoid any penalties and interest. Beyond that, moving cash around throughout the year in expectation of taxes is a must. The less you have to worry about a new tax bill after filing your returns, the better.
TC Falkner 