What are estimated taxes?

Estimated taxes, which are also called estimates or quarterly taxes, are basically the IRS’s way of collecting tax on the money that self-employed people and small businesses earn throughout the year. Since you’re not an employee with tax withholding taken out of your paycheck, estimated taxes are the DIY version of this. 

The payments are made throughout the year and they go toward your final tax bill. Think of these payments as estimated installments. The great thing about paying in installments is that your tax bill is spread throughout the year, making it easier on your finances than one big payment!

Who has to pay?

According to the IRS, “Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.”

Generally, if your business is relatively profitable and you are self-employed, you can bank on paying estimated taxes. 

How do they work?

You make four payments at four different times throughout the year. At the end of the year, you file your taxes. Once you do this, you find out how much you owe, and whether you under- or over-paid in your installment payments. 

If you underpaid, you need to pay to make up the difference at tax time. If you overpaid, you can opt for a refund, or apply the overage to your next installment. 

How much do I owe?

The first option is to base your payments on the previous year’s taxes. After filing, you should receive a form that tells you how much your installments should be. This works well if you have consistent income year to year. 

However, many people experience fluctuations in income. If this is the case for you, calculating your payments in real time is a better option. This can help you avoid vastly underpaying on your installment payments and ending up with a huge bill at tax time. 

How do you calculate in real-time? First, figure out your net income for the period of your estimated taxes. If you use bookkeeping software, you can run a Profit & Loss report to figure this out. If you don’t, subtract your expenses from your total revenue, like this: 

Revenue – Expenses = Net Income

Next, divide your net income by 30%. You might ask, why so high? 

A portion of your estimated tax payments cover your self-employment tax, which is 15.3% (read more on the IRS website). Your payments also cover your income tax. Your exact income tax will depend on your tax bracket, but 15% is a good estimate for most people. If you use Profit First or money mapping, then this is the amount that you save in your tax account. 

However, if you know you’re in a higher (or lower) tax bracket, you can adjust your percentage accordingly. For people in higher brackets, try dividing by 35% instead. For people in lower brackets, 25% may suffice. 

Let’s look at an example: A photographer has a net income of $20,000 for the first quarter of the year. They divide their net income by by 30% and get $6,000. That’s their estimated tax payment for the first quarter. 

$20,000 x .30 = $6,000

You might be wondering how somebody can make sure they have $6,000 laying around every quarter. The answer is to save for your taxes incrementally. 

This is where a strong money system comes in. The Profit First methodology and money mapping are both methods of ensuring that you’re regularly saving for taxes, ideally every month. 

How much should you save each month? We recommend saving 10-15% of all revenue and setting it aside in a separate account.  If you are just getting started and this doesn’t feel feasible, even 5% will help you avoid the surprise of a large tax bill.

When the quarterly deadline rolls around, all you need to do is transfer the money in this account into your checking account and make your payment. 

How to pay?

You can pay online or write a check. Here’s more information from the Franchise Tax Board (California-specific) and the IRS. 

When are payments due? 

It’s important to pay estimated taxes on or before the due date. Otherwise, you may receive a penalty. 

Check with your state requirements to see when your payments are due and how much they should be (in terms of percentage of your income). If you are in California, I have the Franchise Tax Board link for you right here. 

Want further reading? Here are two great articles I recommend for further reading and resources: 

• Everything You Need to Know About Estimated Taxes by Andi Smiles
• Freelancer’s Guide to Estimated Quarterly Taxes on Wherever Writer

You can also get in touch and schedule a free 15-minute Financial Self Care Consultation with me if you’d like to work with a guide to get your business finances on track.