Many people owning their own business love being their own boss. However, one of the drawbacks of self-employment is dealing with a more complex taxing structure. When you are a W-2 employee, your employer may handle your tax withholdings so that you do not have calculate them yourself. However, when you are self-employed, you must handle these calculations yourself. The Internal Revenue Service (IRS) allows business owners to pay their tax obligations through estimated quarterly tax payments toward the final annual tax obligation. If you fail to make these payments, you may be hit with an estimated tax payments penalty. If you are concerned about this penalty or other tax obligations, consider contacting the experienced tax attorneys at Damiens Law at (601) 957-9672 or (901) 499-4466.
What Is an Estimated Tax Payment?
Typically, taxes must be paid as you receive income during the year. For W-2 employees, taxes are taken out of each paycheck. Individuals who receive other income may need to pay estimated tax payments because the United States uses a pay-as-you-go tax system. Therefore, quarterly tax payments take the place of employer withholdings.
For self-employed individuals, estimated tax payments cover income taxes and self-employment taxes. However, if you do not make estimated tax payments quarterly, you may ultimately be charged a penalty. It is important to note that the IRS has special rules regarding estimated taxes.
Who Must Pay Estimated Taxes?
Self-employed individuals who do not pay income taxes through their employer may have to pay estimated taxes if they anticipate owing $1,000 or more in tax for the year, which can include:
- Sole proprietors
Corporations that anticipate owing $500 or more in tax for the year must generally make estimated tax payments.
However, estimated tax payments do not only apply to self-employed individuals. They also apply to individuals who may owe taxes due to receiving income from:
- Capital gains
Individuals may not have to pay estimated tax for the current year if they meet all of the following requirements:
- Their total tax for the previous year was $0 or they did not have to file an income tax return
- They were a United States citizen or resident alien for the entire year
- Their prior tax year covered a 12-month period
When Do I Have to Pay Estimated Tax Payments?
The IRS states that taxes accrued during the following time periods must be paid by the following date:
- January 1 – March 31 – Due April 15
- April 1 – May 31 – Due June 15
- June 1 – August 31 – Due September 15
- September 1 – December 31 – January 15 of the following year
If any of the due dates listed above fall on a weekend or legal holiday, the payment is due the next business day. If a taxpayer does not make the payment that is due by the due date, they may be charged a penalty even if the IRS owes the taxpayer when they file their income tax return for the year.
Taxpayers can pay more often than quarterly if they so choose, as long as the total combined payments equal or exceed the amount of their tax liability for that period.
How to Calculate Estimated Tax Payments
Taxpayers can calculate their estimated tax payments by determining the amount of tax they owe for the year by combining their income tax and self-employment tax. Then, they can divide this figure by four for each quarter. The amount equals the quarterly tax payment that is due.
The IRS provides taxpayers with Form 1040-ES to help them calculate their estimated tax payments. This form helps them calculate the following information:
- Adjusted gross income
- Taxable income
Corporations use Form 1120-W to calculate their estimated tax.
Taxpayers can also refer to their previous tax returns as a starting point to determine their potential tax liability and estimated tax payments.
How to Make Estimated Tax Payments
Taxpayers can complete Form 1040-ES and submit it by mail. Alternatively, they can pay online or through the IRS2Go app. Taxpayers can also pay estimated taxes through their online tax account.
What Is an Estimated Tax Payments Penalty?
The IRS can impose an estimated tax payments penalty when a taxpayer does not pay enough tax throughout the year. This tax may be due because the taxpayer did not have enough taxes taken out through withholdings, failed to make estimated tax payments, or failed to make other taxes that were due for the quarter.
Cost of Estimated Tax Payments Penalties
The estimated tax payments penalty you incur depends on the amount of tax that was underpaid and how long it takes them to make the late payment. The penalty is generally 0.5% of the amount you owe after the due date passes. The penalty increases up to 25% for each partial or full month that passes until you make the payment. Additionally, you may be charged interest, which can fluctuate each quarter. It is important to note that the penalty is based on the quarter and not the year. Therefore, it is possible to overpay in one quarter, underpay in another, and still owe a penalty.
Options for Resolving an Estimated Tax Payments Penalty
You may have several options for resolving your estimated tax payments penalty. An experienced tax lawyer from Damiens Law can consult with you, analyze your particular situation, and determine if any of the following options may help resolve your situation to your satisfaction:
Pay the Payment in Full
The fastest and simplest way to resolve the penalty is to pay any estimated taxes you owe, plus any penalty you have incurred.
Pay the Payment in Part
If you cannot afford to pay the entire amount of back-owed tax, you may be able to make a partial payment. Even though you may still owe an estimated tax payments penalty, the penalty will be lower because the amount of the fee depends, in part, on the amount of the taxes you owe.
Show You Do Not Owe the Tax
If you do not owe a lot of tax, you may be able to show that you do not owe the penalty. The penalty is not imposed if you owe less than $1,000 in tax, you paid 90% or more of the tax you owe for the current year, or 100% of the tax you owed for the previous year.
Ask for Safe Harbor
Even if you technically owe an estimated tax payments penalty, there may be times when the IRS will not enforce the penalty. For example, you may be able to avoid the penalty if you can show one of the following:
- Your business’s adjusted gross income is $150,000 or less and the taxpayer paid 100% of the business’s tax liability for the previous year in equal payments
- The business’s adjusted gross income is greater than $150,000 and the taxpayer paid 110% of the business’s tax liability for the previous year in equal payments
In these situations, the taxpayer may be able to avoid the estimated tax payments penalty. However, they will have to pay any tax they owe for the year by April 15.
Ask the IRS to Waive the Penalty
You may have other grounds to ask the IRS to waive your penalty, such as:
- The taxpayer or the taxpayer’s spouse became disabled during the tax year when estimated tax payments were supposed to be made or in the previous tax year
- The taxpayer retired after reaching the age of 62 during the tax year when estimated tax payments were supposed to be made or in the previous tax year
- The taxpayer did not make the estimated tax payments because of a casualty, disaster, or other unusual circumstance and it would not be equitable to impose the penalty
- The taxpayer had reasonable cause not to make the estimated tax payment, such as a medical emergency or death in the family, a house fire, a natural disaster, or another situation that made the taxpayer unable to make their estimated tax payment on time
- The taxpayer can claim the First Time Penalty Abatement Waiver
Taxpayers can request a penalty waiver by filling out Form 2210 and indicating their request. They must submit a statement explaining the situation and why they were unable to make the payment. They may also need to provide documentation that substantiates their reasoning, such as:
- Medical records
- Receipts of disability income
- Retirement account statements showing distributions
- Police reports
- Court records
- Insurance company reports
Move to the Annualized Income Installment Method
Some business owners may make varying amounts of income each quarter. For example, some businesses are seasonal in nature. Therefore, many of their sales may come from only part of the year. The annualized income installment method allows taxpayers to split up their estimated tax payments to pay taxes in proportion to their earnings. In these cases, a business owner can pay less in taxes when they earn less and more in taxes in quarters when they earn more. Using this method, a business owner could potentially avoid penalties in the future by the IRS.
Contact a Tax Lawyer to Learn More About Tax Payment Penalties
If you are concerned you may owe an estimated tax payments penalty, consider contacting a knowledgeable tax lawyer at Damiens Law for assistance. We can analyze your situation and give you recommendations based on your unique circumstances. You can reach our Mississippi office at (601) 957-9672 or our Tennessee office at (901) 499-4466.