How to Calculate Quarterly Taxes

How to Calculate & Estimate Quarterly Taxes

Are you a sole proprietor, in a partnership, an S corporation shareholder, or self-employed? 

Then you’ll likely be required to make estimated quarterly tax payments, so long as you expect to owe taxes of $1,000 or more. For that, you’ll need to fill out Form 1040-ES as accurately as possible or you could face penalties at the end of the year.  

Want to know how to calculate quarterly taxes? Today, we’ll review:

• What are estimated tax payments
• Who needs to make estimated tax payments
• When you have to pay estimated quarterly taxes
• How to calculate estimated tax 
  

What Are Estimated Tax Payments 

Different types of businesses have different tax rules. Some business entities and individuals are required to pay at least 90% of their taxes throughout the year via estimated tax payments and income tax withholding. Per the IRS: 

“Estimated tax is the method used to pay tax on income that is not subject to withholding. This income includes earnings from self-employment, interest, dividends, rent, and alimony.”

As their name implies, these four estimated tax payments are just that—estimates. Using your best judgment, you have to speculate how much income you’ll be making and then pay taxes on that. 

Why Should You Pay Estimated Taxes?

Businesses choose to pay estimated taxes for the following reasons: 

• Avoiding Penalties – We all have to pay taxes. No one likes it, but it is what it is. Resigned to that fact, it’s best to pay what you owe and on time so as to avoid penalties or fines. Depending on your business’ tax status, you may be legally expected to provide estimated taxes in lieu of withholding. Should you underpay, you could be subject to an estimated tax penalty. 

• Preventing an end of the year tax bill “bomb” – Paying as you go helps with financial planning and allows you to avoid problems come tax time. For many, getting hit by four smaller payments doesn’t hurt your business bank account as much as a single lump sum payment. Plus, it makes it easier to budget and plan your spend.

• Gauging cash flow – You need cash on hand to not only pay your expenses but to also pay your taxes. To be sure that you’re able to pay your quarterly estimated taxes, it’s important to have visibility and control on your cash flow. As you grow, having a firm grasp on managing cash flow will become an increasingly more essential business practice. By starting early, you prepare for the future. 

Who Needs to Make Estimated Tax Payments? 

Not every business entity is expected to make estimated tax payments. But if you’re a sole proprietor, partner, S corporation shareholder, or self-employed, you may be required to so long as both of the following conditions apply: 

Related: C Corp vs. LLC: What's the Difference?

1. You expect to owe $1,000 or more on taxes ($500 for corporations) after subtracting federal tax withholding and refundable credits. 

2. You expect federal withholding and refundable credits to be less than either: 90% of taxes shown on your current year’s tax return, or 100% of the tax shown on the previous year’s federal tax return (covering 12 months).  

In some cases, you may not have to pay estimated taxes for the current year. To qualify for that exemption you need to satisfy the following conditions: 

1. You had no tax liability for the prior year.
2. You were a U.S. citizen or resident for the whole year.
3. Your prior tax year covered a 12-month period.

When Do You Need to Make Your Quarterly Tax Payment?

Due to COVID, the IRS pushed back the filing and payment deadline. Per the IRS, “The Treasury Department and the Internal Revenue Service are providing special tax filing and payment relief to individuals and businesses in response to the COVID-19 Outbreak. The filing deadline for tax returns has been extended from April 15 to July 15, 2020.” 

Because of this extension, the dates for quarterly estimated tax payments haven’t coincided with normal calendar quarters. With that extension in mind, here’s how 2020 shaped up in terms of earned income vs estimated tax payments deadlines:

 2019 Quarter 4:

• Income earned: Sept. 1 – Dec. 31, 2019
• Tax payment deadline: Jan. 15, 2020

2020 Quarter 1:

• Income earned: Jan. 1 – Mar. 31, 2020
• Tax payment deadline: July 15

2020 Quarter 2:

• Income earned: April 1 – May 31, 2020
• Tax payment deadline: July 15

2020 Quarter 3:

• Income earned: June 1 – Aug. 31, 2020
• Tax payment deadline: Sept. 15

2020 Quarter 4:

• Income earned: Sept. 1 – Dec. 31, 2020
• Tax payment deadline: Jan. 15, 2021

Should the normal tax deadlines be reinstated next year, you can expect the tax payment deadlines to be around:

• Jan. 15, 2021
• Apr. 15, 2021
• June 15, 2021
• Sept. 15, 2021

How to Calculate Estimated Tax Payments

The process for calculating estimated tax payments is relatively straightforward, but for the sake of clarity, we’ll run through the process. Here’s how John, a self-employed independent contractor, would calculate his estimated quarterly tax payment each month.

Estimate the Year’s Taxable Income

To calculate his estimated income tax, John will first need to determine how much money he’s likely to make. 

In this case, John expects to earn $100,000 this year. He also has $20,000 in deductible income. Subtracting his deductions ($20k) from expected income ($100k), John is left with a $80,000 adjusted gross income (AGI).

Calculate the Income Tax

John then takes his adjusted gross income ($80k) and multiples it by his income bracket tax rate. According to that rate, he would have an estimated income tax of $14,759. 

Note: Tax brackets are subject to change on a yearly basis. So check to see that you’re using the most recent year’s numbers. 

Calculate the Self-Employment Tax

As mentioned, John is self-employed, which means he will also have to pay a self-employment tax. To determine this tax quarterly estimates, he needs to multiply his estimated total income ($100k) by 92.35%. That is $92,350.

Where does the 92.35% come from? According to the IRS: 

“Generally, the amount subject to self-employment tax is 92.35% of your net earnings from self-employment. You calculate net earnings by subtracting ordinary and necessary trade or business expenses from the gross income you derived from your trade or business.”

But that’s not the only tax that needs to be considered. There’s also the Social Security tax (12.4%) and Medicare tax (2.9%). Together, they represent the 15.3% “self-employment” tax number. 

So, John’s $92,350 needs to then be multiplied by 15.3%. That leaves him with a $14,129.55 estimated self-employment tax. 

By adding estimated self-employment tax ($14,129.55) with the income tax ($14,759) you get John’s estimated taxes total of $28,888.55. 

Add it Up and Divide Into Quarters   

Take John’s estimated taxes total of $28,888.55 and divide it by 4 (four quarters in a year). That’s his number—a quarterly tax of $7,222.14. 

Note: Despite some tax quarters being shorter than others, it’s still recommended to treat each tax payment as a fourth of the total each quarter.

When Filing, Overestimate 

As a general rule, it’s better that you err on the side of overestimating on your quarterly taxes. 

If your payments are short, you may face penalties. Those penalties can be pricey, especially if you dramatically underestimate. Per the IRS the penalties include:

• Interest on money owed – “Generally, interest accrues on any unpaid tax from the due date of the return until the date of payment in full. The interest rate is determined quarterly and is the federal short-term rate plus 3 percent. Interest compounds daily.”

• Failure-to-pay penalties – “The failure-to-pay penalty is one-half of one percent for each month, or part of a month, up to a maximum of 25%, of the amount of tax that remains unpaid from the due date of the return until the tax is paid in full.” 

How much should you overestimate? Not much—3-5% is fine. This extra amount will be given back as a tax return if you end up overpaying.

Consider the The Safe Harbor Rule 

Worried that you may have underestimated your taxes for the year and may now face penalties? 

You can likely avoid those thanks to the “safe harbor rule.” This rule was added as an acknowledgement that it can be difficult to project taxes at the beginning of the year. To address this, they made two provisions:

• Current year safe harbor – If your estimated taxes are at least 90% of the final bill for the current year and you made those payments on time, you won’t pay a penalty. 

• Prior year safe harbor – If you use the previous year as an estimator for your current year tax liabilities, you can ensure that you’re penalty-free so long as you pay 100% of the amount from the previous year’s taxes. 

Control Your Finances and Prepare For Tax Season 

Do you need help preparing for tax season? Need a temporary liquidity infusion? 

Ramp is the solution. 

The Ramp corporate card is the only charge card that can help you control your finances and prepare for tax season. Thanks to features like automated receipt matching and automated expense management, you have the tools you need to accurately estimate your quarterly taxes and then pay them on time.  

Sources: 

IRS. Here’s how and when to pay estimated taxes.
‍IRS. Filing and Payment Deadline Extended to July 15, 2020
Kiplinger. What Are the Income Tax Brackets for 2020?
IRS. Topic No. 554 Self-Employment Tax.  
IRS. Topic No. 653 IRS Notices and Bills, Penalties, and Interest Charges.