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Why You Should Pay Your Estimated Taxes
With all that you have to keep track of in building, running, and scaling your business, paying estimated taxes can seem like another giant hassle. It’s really tempting to just put it off. After all, you’ll pay when you file your taxes, right?
Wrong! For lots of reasons, blowing off your estimated tax payments isn’t the way to go. Here are three good reasons why, plus tips for making sure you stay on top of your obligations when it comes to estimated taxes.
What are estimated taxes and why should you care?
Estimated taxes are the amount of tax you expect to owe for a given tax year. When you’re an employee, your employer takes care of your tax withholding, holding back enough from each paycheck so that you’ve paid at least a minimum amount of your taxes due once tax time rolls around.
But as a business owner, you’re responsible for keeping up with your tax payments throughout the year. Estimated payments are the periodic amounts you make towards meeting your full-year tax liability.
3 reasons you should pay your estimated taxes
1. It’s an IRS requirement. This one’s easy. You are responsible for paying taxes as you “earn or receive” income. If you fail to make minimum tax payments, you could find yourself saddled with an underpayment penalty come tax filing time. And it’s not just the IRS. You typically also have to make estimated tax payments to the state(s) you do business in. Just be aware that the calculations for figuring out your state taxes may differ from how you do your federal taxes. For instance, here are California’s estimated tax instructions, versus Colorado’s.
2. There’s no free lunch. Not paying your taxes as you go through the year doesn’t mean you’ve beaten the system. Since you’ll still have to pay them eventually, you could end up avoiding intermittent, and regular payments only to be hit with a big and unexpected lump sum due come tax time. If you’re still struggling to make cash flow, or if your business has inconsistent earnings, this can lead to serious cash flow problems.
3. It’ll cost you. On top of having to pay the taxes you owe in one fell swoop, you could also end up with a penalty for, to paraphrase a famous line, being months late and dollars short with your payments.
Who needs to pay estimated taxes?
S-corporations need to file and pay estimated taxes if their tax liability is likely to be greater than $500. But there are three exceptions to this requirement, all of which have to be met:
- You had no tax liability for the prior year
- You were a U.S. citizen or resident for the whole year
- Your prior tax year covered a 12-month period
How do you figure out how much estimated tax to pay?
There are a couple of ways to work this out. You could use your prior tax year as a base, divide what you ended up owing in taxes then into four equal installments, and make your estimated payments based on that amount.
Or you could base it on what you expect to owe in taxes this year. That means you’ll have to project out your revenues, making sure to include any deductions and exemptions you expect to take, as well as any big ticket financial transactions you’ve made or intend to make, in your calculations. Since this can get complicated, it’s best to work with your accountant, tax professional, or outsourced CFO experienced in startup tax issues.
Managing your estimated tax payments
Let’s face it, paying taxes is never fun. But there are a few steps you can take to help keep things running smoothly, minimize stress, and stay sane.
First, if you haven’t done this already, invest in a good expense-tracking and reporting system. Knowing where your business stands on a big picture level will be much harder if you’re not on top of the basics. Maintaining clean records, keeping track of your receipts, and knowing what you have coming in the door and going out is crucial to getting a handle on your tax compliance. Bonus: if for some reason, the IRS or state tax authorities question your return, or you get an audit notice, you’ll already have your records in order.
Stay on top of deadlines. IRS deadlines for making your estimated tax payments for the 2020 tax year are: January 15, April 15, June 15, and September 15.
Next do some tax planning with your accountant, outsourced CFO, or tax professional way before year-end, to get a sense of what your future tax liabilities could be. Doing a mid-year tax review is ideal for this. The process will help you figure out what payments you should be making and whether you are on track to meet them. It should also give you time to course-correct if it turns out you haven’t been making enough payments, or to dial back if your revenue run-rate is likely to be lower than you expected. Lastly, a professional can also help you budget for your tax payments throughout the year, stay on top of deadlines, and help you draw up a contingency plan.
About Early Growth
For over 10 years, Early Growth has provided early-stage companies CFO Consulting Services, Accounting for Startups, Taxes, and 409a Valuation. We saw a need in the marketplace for a service that would allow founders to still focus on business while building a healthy financial story. Our Outsourced CFO, Outsourced Accounting, and R&D Credits services have helped many companies grow.