Welcome to the official blog of Brittany Lanphier, managing partner of Lanphier LLP based in Denver, Colorado!
Any tax guidance in this blog is intended for informational purposes only and is not guidance on which Lanphier LLP intends for you to rely. All tax issues specific to your business or family are largely facts-and-circumstances based and you should consult your tax advisor (or Brittany directly) to discuss how this might relate to you.
May 23, 2012
We are still plugging away over here at Lanphier Accounting. Things are “pleasantly busy”, I would say. We still have a steady stream of projects from new and existing clients that keep us busy throughout the week, but we don’t feel quite as frantic and at least have our weekends (for the most part) to ourselves as a family. This past weekend, we made it up to the mountains for some relaxing family time. Brooklyn went for her first swim at the Mt. Princeton Hot Springs and LOVED it. She was all smiles the whole time.
I often get the question of what we do when tax season is over. The summers are usually filled with consulting projects and helping businesses get their books in order. Often we’ll see businesses in the spring whose records aren’t adequate for preparing a tax return, so we spend the summer cleaning them up so we can file extended tax returns in the fall. We also work with a lot of new businesses at this time, helping them set up their accounting systems, training office personnel, and planning for taxes. It is a fun time for us to work more closely with some of the clients we met earlier in the year during tax season.
Understanding Estimated Tax Payments
One of the biggest shifts for new business owners is the need to make quarterly estimated tax payments, rather than relying on an employer’s withholding, to meet their tax deposit obligations. I meet with many business owners who feel very lost and overwhelmed by this prospect, although it doesn’t have to be all that scary.
In this post, I want to discuss the basics of making estimated tax payments. A note to start that I am talking about INDIVIDUAL estimated tax payments here. This is relevant for small business owners who file as a sole-proprietorship or single-member LLC on Schedule C of their Form 1040, as well as those that receive pass-through income from partnerships or S-Corporations on Schedule K-1. This does not apply for C-Corporations that pay tax at the corporate level. These are pretty uncommon now-a-days in the small business world, however.
Tax Deposit Requirement
Let’s start by discussing what you are required to deposit. The general rule is that you are required to deposit the LESSER of:
- 100% of what your tax liability on your prior year’s tax return (110% if your income is $150,000 or more)
- 90% of what you will owe on your current year’s tax return
When I tell this rule to a new client, I get completely blank stares initially. If you think about it though, most (not all) people see their income increase somewhat year to year. Therefore, as long as you deposit as much as you owed in taxes last year, you will not be penalized for under-depositing. Does this mean you won’t owe any taxes when you file your return the following April? Of course not. Let’s look at an example.
If you made $80,000 in 2011, and (for simplicity sake) owed $8,000 in taxes after deductions, you would need to deposit $2,000 per quarter for 2012 to avoid penalties. In 2012, you made $100,000 and owed $10,000 in taxes (again, over-simplifying the tax calculation). You would owe $2,000 when you filed your return, but you would not be penalized for depositing less that you owed because you met the requirements of Rule #1 above.
How does Rule #2 factor in? Let’s say that in 2011 you won the lottery and received a payout of $500,000, therefore your tax liability was $100,000. In 2012, you aren’t going to have the same income so it would be a serious hardship if you were required to deposit 100% of last year’s tax. Therefore, you won’t be penalized if you meet Rule #2 and deposit almost everything (90%) of what you will owe for the current year, regardless of what you owed last year.
Now, before we move on, a new comments:
- When I say “tax liability” and “what you owe”, I am referring to the number shown on Line 61 of your 2011 Form 1040, not Line 76. I have seen a few clients make this mistake on their own and deposit 100% of what they owed with their return in the previous year, and not what the owed in total tax, before any payments are applied. Needless to say, they came up short on their deposits.
- The rules above apply to both estimated tax payments and withholding on your paycheck alike. Therefore, as an employee, if your withholding status is too low and you don’t meet Rule #1 or #2 above, you will also be penalized.
Determining Your Estimated Taxes for the Current Year
As I mentioned above, complying with Rule #1 doesn’t mean you won’t owe anything when you file. It is common for business owners in their first or second year to see income go up considerably from one year to the next. Even though they may not be required to deposit very much, they worry about getting hit with a big tax bill in April.
The best way to get a handle on what you will owe is to do an estimated tax calculation, which will include estimates of your income and deductions for the current year. You can do this yourself if you feel comfortable, but many clients come to us for this so that they feel a little more confident in the numbers they are getting. If you are feeling motivated, there are a few tools out there that can help:
- IRS Publication 505 – Estimated Tax Payment Worksheet
- 1040 Tax Calculator located on our website
When to Pay Your Estimated Taxes
There are four deadlines for estimated tax payments during the year. They are…
- April 15
- June 15
- September 15
- January 15 (of the next year)
The first one always bums people out because they are paying what they owed on their tax return AND their first estimated tax payment at the same time. The second one always sneaks up on people because it is only two months (instead of three) from the previous deadline. I don’t honestly know why they do it this way.
I frequently get the question, “What if I just can’t pay everything in those first 2 quarters? Can I catch up later in the year?” The answer is yes – no one is going to come knocking on your day asking why you didn’t make that 2nd quarter payment. You could be penalized for not making sufficient deposits in a timely manner. The penalties are pretty light (0.25% per month) so some taxpayers just decide its worth it to pay a little bit in penalties so that they aren’t quite as cash-depleted in the early part of the year.
How to Pay Your Estimated Taxes
Filing an estimated tax payment is easy and isn’t anything like filing a full tax return. You simply need to mail your check with a Form 1040-ES voucher, which lets the IRS match your check up with your tax account. You can also set up an individual count via EFTPS.gov to pay your estimated tax payments electronically.
Don’t Forget Those State Taxes!
Assuming you live in a state with an individual income tax, you will need to make state estimated tax payments as well. The deposit requirements vary by state but are usually pretty similar to the federal rules. Typically, the deadlines match up with the federal deposit dates.
One Last Word…
As I mentioned above, I want to reiterate that we are talking about INDIVIDUAL estimated tax payments here, even though I am mentioning small business owners a lot. I emphasize this because you are making these payments under your social security number and never your business EIN. If you have a pass-through business (LLC, S-Corp, etc), the business doesn’t owe any income tax and the tax liability is yours, individually.
I once had a client come to me at tax time who had been advised by their bank to use their electronic business tax deposit system. The bank, however, was making payroll tax deposits (for the business) and not estimated tax deposits. Since he was a sole proprietor with no other employees, he was not required to file payroll tax reports and this created quite a mess. He had to pay a large sum with his return and wait for a refund of what he’d paid through the bank’s payroll tax deposit system.
(Final Caveat: If you have an S-Corporation, this is a bit different. You should be paying yourself a salary as an employee of the S-Corporation (see this post), and if you are withholding on those wages, you may be able to avoid making estimated tax deposits, assuming you meet one of the deposit rules stated above).
Alright, I start getting all twitchy at the end of my blog posts because there are a hundred nuances, exceptions, and scenarios that I didn’t cover. Hopefully this at least gave you a brief overview. As always, if you have specific question on your particular circumstances, give us a call and we will be happy to consult with you.
Best to all!