Have you ever wondered why your small business is paying so much in taxes? The answer may be simple: You may not be paying as you go. If you don’t pay enough taxes during the year, you may pay a penalty for underpaid taxes. Here’s how to do it correctly.
If You Aren’t Withholding Taxes, You Need to Pay Estimated Taxes Quarterly
According to the Small Business Administration, both state income tax departments and the Internal Revenue Service require individuals and businesses, including small businesses, to pay taxes almost immediately after earning income. Many businesses pay the taxes by withholding taxes from wages and other payments. Those that don’t must pay quarterly estimated tax payments.
Some call the estimated taxes a “pay-as-you-go” tax. You must pay the government enough from your income to cover self-employment taxes for Medicare and Social Security obligations and self-employment taxes four times per year.
There are severe penalties for not paying enough taxes either in estimated quarterly tax payments or through withholding. The IRS does understand that calculating earnings is difficult, so to protect small businesses, it has created a safe harbor rule. Simply put, this means that if you pay within 90 percent of your actual liability, or the total liability from the previous year, you will not have to pay a penalty.
Who Owes the Taxes?
Even if you have just formed your new small business, you no doubt already know paying your taxes on time and accurately is important. Sometimes small business owners don’t realize, however, that the self-employed must make the estimated payments four times annually.
Actually, startup founders do not have to make estimated taxes during their initial year of operation. They must make them every year thereafter, however.
Those filing as sole proprietors, partners, or S-corporation shareholders must make the estimated tax payments, if they expect they will owe $1000 or more for the tax year.
If your business is, instead, structured as a corporation, you must estimate taxes if you believe you will owe $500 or more when you file.
The Penalty is Severe
The IRS typically adds a penalty of 0.5 to 1 percent per month to an income tax bill not paid on time. The computerized penalty computerized and is added automatically whenever a return is filed, without the full payment amount, or for a late payment. In addition, the penalty for not making a payroll tax deposit on time is a lot higher. That is why it is important to pay the taxes on time. The good news is the IRS may allow you to establish a payment plan. The flat rate fee you will pay will be less than the monthly penalty you would be responsible for.
How to Calculate the Taxes
To calculate the taxes, determine your anticipated adjusted gross income, taxable income, deductions, taxes, and any allowable credits. Naturally each business situation is different. For this reason, it is vital, especially for new business owners, to spend time with a tax expert to determine how best to calculate for your business.
Is This Your First Time to Make Quarterly Payments?
If it is, but this was not your first year of operation, use the money you made last year as an estimate, as well as your deductions and tax credits. That should make it easier to estimate this year’s expected tax burden and pay at least 90% of the taxes you will owe.
There is a Benefit to Paying the Self-Employment Tax
While you are responsible for paying the self-employment tax to cover Social Security and Medicare, you can deduct employer-equivalent component of what you owe. For example, a $10,000 payment decreases by $5,000. While you’re paying your taxes, don’t forget, if your business is new, to use all the allowable deductions for startup and business expenses.
Don’t Forget Your State Taxes
While you’re at it, don’t forget to pay state income taxes when you pay the IRS.
Paying as you go to save on your taxes isn’t that hard with a little planning, and it never hurts to talk with a tax expert. For more information, feel free to contact us.