Estimated Taxes 101: The "No Surprise Bill" System
April is a stressful time for many business owners and freelancers. If you don’t have someone withholding taxes for you, don’t wait until tax season for the sticker shock. Estimated taxes are all part of staying on top of your finances and you should have a very good idea of how much you owe long before it’s time to pay up.
What Are Estimated Taxes?
Employees generally have taxes taken out of their paychecks automatically. If you’re a contractor, landlord, or someone with a side hustle, you’ll need to plan ahead for taxes. By using estimated taxes, you spread the pain out over the year, rather than paying it all in a massive tax bill come April.
These pay-as-you-go IRS payments are done throughout the year. Generally, you’ll pay four times a year, once each quarter. Your tax payments are due April 15, June 15, September 15 and January 15 next year. And, here’s the kicker… if you don’t pay enough throughout the year, the IRS may end up charging you a penalty.
Who Needs to Pay Estimated Taxes?
Anyone who owes more than $1,000 and doesn’t have their taxes withheld automatically should check if they need to pay estimated taxes. That’s $1,000 after subtracting any withholding and refundable credits.
Not sure if you fit this category? The simplest way to find out is to ask a tax expert. They’ll let you know what you should do moving forward.
Calculating Your Estimated Taxes (Even If You Failed Math)
Calculating taxes sounds pretty intimidating, but you can do it step-by-step. You’re going to use last year’s federal return as your handy cheat sheet, since it can be a useful starting point.
Step 1: Compare last year’s return to what you expect this year. Form 1040-ES includes a worksheet for figuring out your estimated tax.
Step 2: Estimate this year’s income. You should include anything that brings in money, including:
Business income
Rental income
Investment income
Side hustle income
Any other untaxed income
If there is no tax withheld, you need to consider it in your estimations.
Step 3: Account for expected deductions. This is fairly simple, just check which deductions or credits you’re eligible for. According to the IRS, estimated tax is based on taxable income, taxes, deductions, credits, and expected AGI.
Step 4: Do the math next. You can roughly estimate the amount by assuming a certain amount of increase over the previous year’s taxes, set aside a percentage based on your experience, and then divide by 4 to get the quarterly payment.
However, if you really want to be more accurate, you can use the 1040-ES worksheet. You may need to recalculate throughout the year if your income decreases or increases drastically.
Still Confused?
Don’t worry, you’re not alone. There’s a good reason people hire tax pros to work out exactly what they need to do. You don’t have to do everything yourself as a small business owner, so go ahead and contact Ask Anna Tax today to outsource the tough stuff. As a bonus, you’ll find out if you’re eligible for any additional deductions or tax credits!
