Now that another tax season has come to an end, it’s a good time to take stock of your situation, and consider what you might do to improve your situation going forward. One of the best ways to do this is to plan your quarterly tax payments. Year round tax planning can save you money, since you have more time to be tax efficient, and it can also help you better manage your cash flow so that you aren’t scrambling to pay your tax bill.
Who Needs to Make Quarterly Tax Payments?
First of all, you need to determine whether or not you need to make quarterly tax payments. If you are a W-2 employee, working for someone else, your taxes are automatically withheld from your paycheck, so you don’t have to worry about it. You should still engage in year-round tax planning, managing your deductions and credits, and keeping your paperwork organized, but you don’t need to worry about quarterly tax payments.
The story changes if you are self-employed, however. If you are self-employed, and you expect to owe at least $1,000 at tax time, the IRS expects you to make quarterly payments. Your quarterly tax payments should include estimates of what you will owe in self-employment tax.
How Much Should You Pay in Estimated Quarterly Taxes?
Your quarterly payments are estimates, and the IRS understands this. You either need to go through the process of figuring out what you owe each quarter using a somewhat involved formula, and making sure that you pay at least 90 percent of what you owe, or you can take the easy way out.
I like the easy way.
The IRS won’t penalize you if your quarterly estimated payments add up to 100 percent of what you owed last year. So, if you owed $6,000 in taxes last year, you can pay $1,500 each quarter and not worry about a penalty. I’m a big fan of just figuring my taxes this way.
Of course, if you make more money this year than you did last year, you will owe money come tax season, since you are paying based on the previous year’s tax bill. Since my husband has a “real” job, while I have the solopreneur gig, we have his withholding set a little higher than it would normally be. That way, if I bring in more, what has been withheld from his paycheck normally does what it needs to.
Another options is to take what you owed the previous year, and add 10 percent to leave a little cushion. Or you can just suck it up and pay the bill when it comes due.
Easing Your Cash Flow with Quarterly Payments
One of the biggest pitfalls is forgetting about state taxes. I’ve done this in the past. It’s important for you to remember that states levy taxes, too. Many states don’t require quarterly payments, so it can be hard to remember these taxes.
What I like to do is take my total tax bill, state plus federal, and divide that by four. So, if you owe $6,000 in federal taxes and $4,000 in state taxes, your total tax bill is $10,000. Here’s what I do to make the cash flow a little easier to manage:
- Divide the total tax bill by 12.
- Each month, make a “payment” into a high-yield savings account.
- Every quarter, send in my federal estimated payment, leaving the state portion to sit in the account, continuing to earn interest.
- At tax time, I’m usually caught up with federal, and I can use the money still in the account to pay state taxes. What’s withheld from my husband’s paycheck usually covers most excess, so I don’t often owe more than $2,000 extra total.
- Add up the new tax bill, and divide that by 12 for the coming year.
If you owe $10,000 total, that amounts to setting aside $833.33 each month. You have to start in January to make it work, though, since your first quarterly payment of the year will be due on April 15. You can also use this method to ease your cash flow after April; just divide the total by eight to get $1,250 per month.
Part of running your business is figuring in your quarterly estimated tax payments. Make sure you factor them into your planning, or you’ll run into a crunch later.