Estimated Tax Payments and Federal Withholdings

What are Quarterly Estimated Tax Payments?

Quarterly Estimated Tax Payments are a method used by the IRS to collect tax on a variety of incomes that are not subject to Federal Tax Withholdings – Essentially non-payroll related income.  The IRS sets these payments up to be made in four equal instalments throughout the calendar year.  The total estimated tax payment is usually calculated based off 110% of the previous tax year’s income.  IE, if you made $75,000 in 2016, your estimated tax payment is based off a projected income of $82,500 for 2017.

Typically, when your tax return is filed, the finalized copy will have payment vouchers included for you to use in the following year.  These vouchers include the due date, as well as the amount due for the payment.  Simply include this slip in your remittance to the address provided, and send both the slip and a check off in the mail.

What Happens if I Don’t Pay the Estimated Tax Payment?

The IRS will levy an underpayment penalty if you fail to pay enough estimated tax throughout the year.  The amount of the penalty varies depending on the situation, and it is difficult to estimate the penalty ahead of time.  Typically, if you end up owing $1,000 or less after all withholdings and deductions are applied, the IRS will waive the fee.  However, it is a good policy to aim to pay taxes on 110% of last year’s income if you made more than last year, or pay taxes on 90% of last year’s income if you made less. 

Alternatives to Making Quarterly Payments

Much of the time, self-employed owners find that paying the estimated taxes on a quarterly basis is still a major cramp on their cash flow, and they are right.  Coupled with not knowing what you will be making over the whole year, making these payments can seem daunting and unfair.   The same goes if you have a cyclical business (IE, painting houses, or renting paddleboards).  Instead, S-corp owners can utilize the required payroll to increase their Federal Withholdings to act as their estimated tax payment.  If the owner is already paying a salary, Federal Withholding is automatically calculated and taken out of the net check on a per-paycheck basis.  This withholding covers the personal tax obligation for the W2 income, and the owner can increase the withholding amount to cover K-1 earnings from the S-corp.

Benefits for the Federal Withholding Method

One of the benefits of this method is that the IRS does not track precisely when the withholding occurs and is paid, beyond recognizing what calendar year it is contributed in.  This means, if no estimated taxes or additional withholdings have been paid out, and its December, an owner can run an additional payroll, and pay the net check to federal withholding to boost the estimated taxes paid.  The IRS will not penalize the owner for having made a “late” payment. 

Alternatively, the main attraction of this federal withholdings method, is that it allows the owner to spread the payments over the full year. Instead of making one or four large payments, owners can break it out over 12 months to ease cash flow.  If an owner has a bad month, it is alright to skip the payroll that month, and get back on track the following period – Happily, the rate and schedule is not locked in, and is far more flexible when drawn out over the entire year.

Using the Federal Income Tax Withholding as your estimated tax payments is one of the hidden benefits of the required owner’s salary.  Additionally, if the owner utilizes the payroll method, the payroll company will ensure that the withholdings get paid out on time and to the correct place – No more worrying about whether your check got lost or if you wrote your account number incorrectly.

Quarterly Estimated Tax payments are an important compliance element, and there are several methods that can be used to follow the guidelines.  No matter which method you choose, don’t forget to pay those taxes!