Unfortunately for some business owners, when they go to file their annual tax return it comes as a complete surprise that they were supposed to make estimated tax payments during the year. Sometimes new business owners are unaware of the federal tax law that requires a business owner to project their income after expenses and make estimated tax payments. Generally the rule for federal tax liability is you must pay estimated tax for the year if the following applies:
Sole proprietors, partners, and S corporation shareholders - You generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return. To determine your estimated taxes, use Form 1040-ES, Estimated Tax for Individuals, to figure and pay your estimated tax. For additional information, refer to Publication 505, Tax Withholding and Estimated Tax.
If you receive salaries and wages, you can avoid having to pay estimated tax by asking your employer to take more tax out of your earnings. To do this, file a new Form W-4 with your employer. Publication 505, Tax Withholding and Estimated Tax, provides more information about these special estimated tax rules.
Corporations - You generally have to make estimated tax payments for your corporation if you expect it to owe tax of $500 or more when you file its return. Use Form 1120-W, Estimated Tax for Corporations, to figure the estimated tax. You must deposit the payments. For additional information, refer to Publication 542, Corporations.
How to Figure Estimated Tax
To figure your estimated tax, you must figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year.
When figuring the year's estimated tax, it may be helpful to use your income, deductions, and credits for the previous year as a starting point. Use your last federal tax return as a guide. You can use Form 1040-ES to figure your estimated tax.
You must make adjustments both for changes in your own situation and for recent changes in the tax law.
When to Pay Estimated Taxes
For estimated tax purposes, the year is divided into four payment periods specified on Form 1040-ES. Each period has a specific payment due date. If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return.
Using the Electronic Federal Tax Payment System (EFTPS) is the easiest way to pay your federal taxes for individuals as well as businesses. Make ALL of your federal tax payments including federal tax deposits, installment agreement payments and estimated tax payments using EFTPS.
This information provides a brief overview from the Internal Revenue Service of issues and decisions involved in owning a small business and avoiding common pitfalls.