Have To Pay Estimated Taxes? 4 Ways To Avoid IRS Penalties
If you're a small business owner or entrepreneur, you already know that you have to set aside and pay your own income taxes. But how much should you pay and when? While estimating your income can be difficult, the IRS does provide some guidance to make tax payments a little easier. Here's a guide to how to use that guidance to avoid penalties.
1. Use Last Year's Taxes. The IRS rules generally expect you to contribute estimated payments equal at least to 100% of the prior year's income tax liability. This is a useful number to use as a minimum for this year's payments if income is stable. Divide this number by four and make one payment each quarter on time. If your income was greater than $150,000 last year, though, increase these payments to equal 110% of last year's numbers.
2. Learn the Tables. While most Americans rely on software to tell them what their tax rates are, there are ways to learn this information before tax time. You may be able to use last year's tax liability as a guide. But if that isn't a reliable guide, talk with a CPA (Certified Public Accountant) about how to read the tax tables to estimate your future liability. These tables show what the percentage "brackets" are and when you will enter a higher liability range.
3. Estimate High. If you don't have a good way to judge your expected income for the current year, it's best to overestimate what you'll earn. If you base your estimated payments on a higher-than-expected number, you won't have to worry about underpayment penalties. And you may have some unexpected savings that you can then use to invest in your business in the new year.
4. Boost Withholding. If you or your spouse (if filing jointly) still have a regular wage-earning job, lower exemptions on Form W-4 with that employer. By lowering exemptions to zero, you will have a larger amount of taxes taken from each check. These withheld amounts will be pooled with self-employment tax payments to help cover your shared tax liability. If you can keep the amount you owe in April to less than $1,000, you will likely not owe any penalties.
Estimating tax payments is challenging. If you have any doubts, talk with an experienced CPA as early in the year as possible. This will help you create a payment schedule, pay on time, and avoid underpayment penalties next spring.