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If you're a sole-proprietor, the IRS requires you to make quarterly estimated income tax payments. This guide walks you through the entire process: from estimated your tax liabilities to sending payments to the IRS.
What are quarterly taxes?
Quarterly taxes are payments made by self-employed individuals, including sole proprietors, to pay estimated tax on their business income for a given year. The IRS requires taxpayers to pay tax on income as it is earned, not all at once when filing a tax return. For the self-employed, this means you must pay estimated tax on your business income in quarterly installments.
Estimated tax is the amount that you expect to owe when filing your tax return after subtracting deductions, credits, and withholding from other income sources .
To make quarterly estimated tax payments, first calculate your estimated annual tax liability, then divide that amount by four, and then remit payments to the IRS according to the estimated tax payment schedule that is published annually.
Note that this guide covers IRS requirements. Many states also require quarterly estimated tax payments. Check with your state to confirm.
Who has to pay quarterly taxes?
You must make estimated tax payments if both of these conditions are true:
- You will owe $1,000 or more when filing your tax return (after tax credits & withholding);
- Your withholding and tax credits will be less than the smaller of:
- 90% of your estimated tax liability; or
- 100% of the tax shown on your 2021 tax return.
Not everyone is required to pay quarterly estimated taxes. For example, individuals working for an employer have taxes automatically withheld from each paycheck. If their employer is withholding the correct amount, they should owe less $1,000 when filing their tax return and, therefore, aren’t required to make estimated tax payments.
Self-employed individuals are required to make estimated tax payments because their business income isn’t subject to withholding. Taxes aren’t automatically withheld from their income and they’ll usually owe more than $1,000 when filing their tax return. Therefore, self-employed individuals must make estimated tax payments quarterly to the IRS.
How to calculate estimated taxes?
To calculate your estimated tax liability, first estimate your total income, deductions, and tax credits for the year. Then you should calculate your estimated tax liability using the IRS rate schedules (incomes taxes plus self-employment taxes) and divide that amount by four. The result will be the installment payment you must make each quarter.
As a self-employed individual, your total income will be your net business income after deductions plus taxable income from other sources. Other income sources might include stocks, a spouse’s income, and income from other businesses you own.
You can use either the standard deduction or itemized deductions to estimate your deductions. The standard deduction is simpler to use for estimated calculations. It’s a fixed amount and available to all taxpayers. Not all taxpayers will benefit from itemizing their deductions.
Your estimated tax credits will include tax credits that you’re eligible for in addition to employer withholding and estimated tax payments already made by you or your spouse.
The IRS provides Form 1040-ES to assist taxpayers in calculating their estimated tax liability and quarterly installment amount. Use the “Estimated Tax Worksheet” in this form to calculate your estimated tax liability. This form also includes estimated tax payment due dates for the year.
A walkthrough of calculating your estimated taxes
Here’s an example of how Kris, a sole proprietor, would calculate their total estimated taxes (income taxes plus self-employment taxes) for 2022.
Step 1: Estimate Adjusted Gross Income
Kris estimates that their business will generate $100,000 in income after subtracting deductible business expenses. Assuming Kris has no other income, Kris’ taxable income before personal deductions would therefore be $100,000.
Kris estimates that they’ll take $5,000 in adjustments income since they contributed to a Traditional IRA during the year.
Kris also intends to take the standard deduction, which is $12,950 for 2022.
Finally, Kris deducts 50% of their self-employment tax (calculated below). Self employment taxes will be $14,130, which means Kris can deduct $7,065 from taxable income.
Subtract adjustments and deductions from taxable income to calculate Adjusted Gross Income: $100,000 - $5,000 - $7,065 = $87,935.
Step 2: Calculate estimated income tax
Kris then calculates estimated income taxes by multiplying Adjusted Gross Income by the applicable income tax rates on the Tax Rate Schedules in Form 1040-ES for 2022.
As a taxpayer filing single, Kris estimated income tax is calculated as follows: $4,807.50 + (.22 x ($87,935 - $41,775)) = $14,963.
Step 3: Calculate estimated self-employment tax
Kris then calculates self-employment tax owed on net business income. The quick and easy way to calculate self-employment income is to multiply net business income by 92.35% and then multiply that number by 15.3%.
Self-employment tax = $100,000 x .9235 x .153 = $14,130.
Refer to the Self-Employment Tax Deduction Worksheet in Form 1040-ES for a more detailed calculation.
Step 4: Calculate estimated tax installments
Finally, Kris calculates quarterly estimated tax installments by summing together their total estimated income tax and total estimated self-employment tax and then dividing by four.
Total tax liability = $14,963 + $14,130 = $29,093.
Quarterly installment = $29,093 / 4 = $7,273.
Kris will pay the quarterly installment amount four times during the current tax year.
When are quarterly taxes due?
You should make quarterly estimated tax payments according to the schedule below.
- Q1: April 15th
- Q2: June 15th
- Q3: September 15th
- Q4: January 15th
If one of the above due dates falls on a Saturday, Sunday, or federal holiday, your payment will be on time if you make it on the next day that's not a Saturday, Sunday, or federal holiday.
For example, if September 15th is on a Sunday this year, your Q3 estimated tax payment made on September 16th would not be considered late.
Where to make quarterly tax payments?
You can make quarterly estimated tax payments by mail or online.
The IRS’ Direct Pay portal is the quickest and easiest way to pay online. Click “Make payment” > Select “Estimated Tax” as the reason > Apply payment to 1040ES > Select the current year as the tax year. You’ll then need to verify your identity by referring to a prior year’s tax return (also called “1040”). Once verified, enter your bank info and select a payment date.
Alternatively, you can make quarterly estimated tax payment by mailing the IRS a check. Include the applicable payment voucher from Form 1040-ES when mailing your payment. Failing to include a payment voucher might mean that your check gets lost or applied to the wrong taxpayer.
Your state tax authority might also have an online portal for making estimated tax payments. Google “pay estimated taxes online” for your state to find the payment portal. Be sure that you’re taken to an official state website prior to making any payments.
You will receive a receipt when making an estimated tax payment. Save these receipts for later reference when filing your tax returns. You’ll need to report estimated tax payments made during the year. Saving . If you lose track of any estimated tax payments made during the year, check your bank statements, the IRS Direct Pay portal, or your online IRS account.
What are the penalties for underpaying estimated taxes?
You might be charged an underpayment penalty if you paid less than your estimated tax liability during the year.
For example, if you underpaid your second quarter installment but paid enough on your third quarter installment, you’d be charged an underpayment penalty on your second quarter installment only.
Underpayment penalties are figured based on each quarterly installment of your estimated tax liability, not on the total annual estimated tax liability. This means that you might be charged a penalty even if you paid 100% of your tax liability during the year.
For example, suppose that you skipped your first, second, and third quarter estimated tax payments and paid 100% of your estimated tax liability prior to the fourth quarter estimated tax payment due date. You will owe no tax when filing your tax return, but the IRS will charge you an underpayment penalty on the amounts that should have been paid in quarters one through three.
Underpayment penalties are equal to a percentage of the underpaid tax balance and compounded on a daily basis. The interest rate varies by quarter and is set by the IRS.
For example, if you underpaid your second quarter estimated tax installment by $10,000 and you made the payment 10 days late on June 25th, your underpayment penalty would be $8 for this quarter ($1,000 x (10 days / 365 days) x .03), assuming a three percent interest rate.
Avoid underpayment penalties with the Safe Harbor Rule
Sole proprietors can avoid underpayment penalties by making sufficient estimated tax payments on a quarterly basis according to the estimated tax installment schedule for the current tax year. Due dates for estimated tax payments are published on the IRS website.
What amount qualifies as “sufficient?” Use the “Safe Harbor Rule” to answer this question.
Under the Safe Harbor Rule, by paying 100% of the tax you owed for the previous year through estimated tax payments, you’ll avoid underpayment penalties. This amount is 110% if your Adjusted Gross Income exceeded $150,000 for the previous year.
For example, suppose you reported Adjusted Gross Income of $80,000 and paid $16,000 in taxes when filing last year’s tax return. To avoid underpayment penalties for this tax year you’d need to pay at least $16,00 ($4,000 quarterly) in estimated taxes during the year.
Conclusion
Sole proprietors should make quarterly estimated payments during the tax year to avoid underpayment penalties. It’s not only recommended, but the IRS also requires it for any individual, such as sole proprietors, not subject to tax withholding through an employer.
Estimating your tax liabilities and making sufficient quarterly payments can be hard. Working with a CPA or tax professional who can help estimate your tax liabilities and provide other strategic tax advice takes the stress out of paying estimated taxes. Get in touch with Augur Advisory Group to see how we can make estimated tax payments stress-free.
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