Estimated taxes for business owners: avoiding the April surprise

An employee’s tax is withheld from every paycheck. Most business owners have no one doing that for them: profit from a sole proprietorship, a partnership or an S corporation flows to the owner’s personal return, and the tax on it is due as the income is earned — not only in April.

The way to pay it is through quarterly estimated tax payments. Owners who skip them, or pay too little, can owe an underpayment penalty on top of the tax, even if everything is paid in full when the return is filed.

When the payments are due

For individuals on a calendar year, federal estimated payments are generally due in four installments: April 15, June 15 and September 15 of the tax year, and January 15 of the following year. When a date falls on a weekend or holiday, it moves to the next business day. Most states that tax income have their own estimated payments on a similar calendar.

How much to pay: the safe harbor

The underpayment penalty generally does not apply if your payments and withholding for the year cover at least the smaller of:

• 90% of the tax shown on this year’s return, or
• 100% of the tax shown on last year’s return — 110% if last year’s adjusted gross income was more than $150,000 ($75,000 if married filing separately).

The prior-year figure is known in advance, which makes it the simplest target. The catch is that it only protects you from the penalty. If this year is much better than last year, the rest of the tax is still due in April, and it can be a large number.

Keeping the payments in step with the year

Estimated payments work best when they are revisited during the year rather than set once in January. A few habits help:

• Keep the books current, so each quarter’s payment can be based on actual results rather than a guess.
• Revisit the estimate before the June and September payments, when the shape of the year is clearer.
• Remember the state. A state estimate that was right last year can be well off this year.
• Set the money aside as it comes in. A separate savings account for taxes turns a quarterly payment into a transfer instead of a scramble.

If you also have wages — from a spouse’s job, or a salary from your own S corporation — increasing withholding late in the year is another way to catch up. Withholding is generally treated as paid evenly through the year, even when it is withheld late in the year; a late estimated payment is not.

Where planning comes in

The payment itself is arithmetic. The value is in knowing, before the year ends, where it is heading — and what decisions are still open. That is the work of year-round tax planning, and it starts from books that are kept current each month.