How I Talk to Clients About Quarterly Taxes

For many Americans, tax day conjures images of a single deadline in April each year. However, tax day arrives quarterly for many small business owners, freelancers, and those with non-wage income such as rental or investment earnings. This is because the U.S. operates under a pay-as-you-go tax system, which requires taxpayers to pay taxes on income as they earn it throughout the year.

Key Takeaways

• Small business owners and self-employed workers must make quarterly tax payments to the IRS and state tax authorities.
• These quarterly taxes are estimated payments based on this year’s income.
• Your CPA or accountant can help you calculate your total tax liability for the year, which will form the basis for estimated tax payments.
• Divide your estimated quarterly payment by three and set aside that amount each month to ensure that you have sufficient reserves.  

What Are Quarterly Taxes?

Quarterly taxes are estimated payments made to the IRS or relevant state tax authority to cover taxes due on income, self-employment, and other taxable activities. Without proper planning, these quarterly payments can derail your financial goals and plans (as I’ve witnessed happen to multiple small business owners).

What I’m Telling My Clients

Estimate taxable income for the upcoming year: You’re paying taxes on this year’s income (not the previous one). While you may not have the firm numbers available early in the year, an estimated income projection is important. This estimate will be shared with your CPA or accountant to determine the dollar amount or percentage you need to set aside on a monthly basis to cover your payments. 

Estimate tax liability: Work with your CPA or accountant to calculate your total tax liability at both the federal and state levels based on the projected numbers you provided. This will take into consideration deductions and credits, which can reduce taxable income, and thus your tax liability, and also includes any self-employment taxes covering Social Security and Medicare.

Determine estimated payments: Divide the calculated tax liability by four to determine how much needs to be paid each quarter.  

Set aside funds: To manage cash flow effectively, divide the quarterly payment by three and set aside that specific dollar amount each month. When quarterly payments are due, the money will already be there waiting for you. Send in the amounts you’ve set aside for that specific payment period. 

A Caveat

It’s important to recognize that estimated tax liabilities are just that—estimates. Actual earnings can differ from projections, leading to higher or lower tax liabilities. In order to avoid being hit with a large tax bill in the event your income comes in significantly above what was estimated, stay current with your profit and loss statements or income trackers. Should you note any discrepancies, work with your CPA to make the necessary adjustments to set aside funds to cover the difference. 

The Bottom Line

Staying on top of quarterly taxes takes organization and preparation. It may be work, but it helps to ensure you avoid costly penalties and that you stay on track for your financial goals throughout the year. 

Read the original article on Investopedia.