The Beginner's Guide to Navigating & Paying Estimated Taxes
When I first started my business, I found estimated taxes to be hard to wrap my head around. It was something completely new to me.
Well, that’s actually putting it (really) nicely. Here’s the not-so-pretty truth: I was confused out of my mind and—having been a person that had always received a refund on my taxes—I was freaked out that I not only had to pay taxes, but the amount I had to pay in was pretty startling.
Business owners have to deal with enough bushwhacking without having to venture into IRS territory more than they have to! So, let me break down estimated taxes for you . . . in non-IRS speak.
What Exactly Are Quarterly Estimated Taxes?
Most people are familiar with the tax system from an employee standpoint—you have taxes taken out of your paycheck and file your returns by May 17th in 2021. However, unbeknownst to you, your employer was secretly doing more tax legwork for you behind the scenes. Remember that w-4 you fill out when you started a job? It asked how much you wanted withheld.
That’s what employers use to figure out how much to take out of each paycheck and send in to the IRS. As an employee, you just filled out that form and you were done until it was time to file your taxes. Your employer, on the other hand, was responsible for setting aside the money for taxes (both your portion and their portion) and paying it in a timely manner.
Now that you’re the business owner, however, you’re in charge of making sure Uncle Sam gets the money he’s looking for. That means you get to pay these things called estimated taxes.
While estimated taxes may seem complicated, they’re really not. The big idea is that you, as a business owner, generate income. And income is subject to taxes. Just like when someone owes you money, you don't want to wait a full year to get it, the IRS doesn't want to wait to get their slice of the pie until May 17th. As it happens, a quarterly payment plan seems to please the IRS.
And that’s really what estimated quarterly taxes are. Same idea as when you were an employee, except now you’re a business owner, you're responsible for setting aside the money and paying taxes on a quarterly basis.
Where Is that Money Really Going?
When it comes to paying your first year of estimated taxes, you’ll probably be surprised at how much of your business earnings end up going to the IRS. Essentially, your estimated taxes are a combination of what you owe for income, Social Security, and Medicare taxes.
You may experience sticker shock. But don't worry, you get used to it. :)
To avoid any surprises, expect that if you’re earning the same amount (after deductions) that you did when you were an employee, you’re going to pay more in taxes now that you’re self-employed. Why? Well, while you paid income tax out of every paycheck as an employee, your employer paid half of another set of taxes—Medicare and Social Security. Now that you’re the business owner, Medicare and Social Security taxes are 100% your responsibility.
So, how much more do you pay as a business owner? The Social Security and Medicare taxes you now have to pay—together they’re often called the self-employment tax—currently ring in around 15% of your adjusted gross income (that is, your income after deductions/exemptions).
Keep in mind that the 15% self-employment tax is above and beyond the income tax you've always paid (and will continue to pay). That, my friends, is why you should prep yourself for sticker shock. You could very well owe 25% of your earnings or even upwards of 40% depending on your income bracket and state tax levels.
Amidst this depressing news, here’s a bright spot to keep in mind. Remember that you get to deduct half of your self-employment taxes when you file. Small joys, people. That’s all we can shoot for. :)
How Do You Know How Much to Pay?
Now that you know what estimated taxes are, how in the world do you figure out how much you owe? Good question.
You can take one of two approaches:
If you’re brave, you can fill out the 1040-ES worksheet and that will help you figure out your estimated quarterly taxes. As the IRS states so casually, “To figure your estimated tax, you must figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year.”
Uh… yeah. I’ll get right on that.
The Better Way
I’m a total DIYer (as are most entrepreneurs) but seriously, we’re in travel. I think it’s safe to say that numbers and accounting are not most of our fortes. My advice? Find a good tax advisor and become best friends.
Mine charges $75/hr and she is worth her weight in gold. Kinda like how travel agents are worth their weight in gold when you find the right one. ;) (We chat with a travel-industry-specific CPA in our travel agent travel expense article if you want a launching point for your search.)
While the lion’s share of your estimated tax payments will go to the Feds, remember you may also need to pay in estimated taxes to the state.
P.S. There is a small chance you may not need to pay estimated taxes as a self-employed person. Here’s a few exceptions to the rule.
When Are the Estimated Taxes Due Dates?
You pay estimated taxes four times a year (quarterly). The due dates may vary by a few days every year due to weekends but typically you pay in on the 15th of April, June, September, and January.
They made it easy for you in 2021! Same date every quarter:
- 1st Quarter: April 15, 2021
- 2nd Quarter: June 15, 2021
- 3rd Quarter: September 15, 2021
- 4th Quarter: January 15, 2022
How Do I Pay My Estimated Taxes?
There are a couple ways to pay your federal quarterly estimated taxes:
1. Snail Mail:
Get yourself a payment voucher and mail the IRS your estimated taxes. (Sample estimated tax voucher below, they’re found at the end of the 1040-ES form)
Apply Your Refund: Instead of getting a refund check from Uncle Sam, you can apply that towards your future estimated tax payments.
If you’re dying to talk to someone at the IRS (weird, but to each their own) you can call in your payment.
Here’s a link to more info on the payment options.
All of the above pertains to the federal estimated taxes. When it comes to how you can pay at the state level, you’re going to have to do a little digging on your state’s tax site.
How Much is the Estimated Tax Penalty if I Underpay?
Right now, for tax year 2020, it's directly tied to how much you underpaid. Now, finding the exact amount for how much you owe? Good luck on that one.
There isn't really an estimated taxes penalty calculator but you can figure it out a few ways:
1) Read the IRS’ overly-complicated explanation on figuring out the penalty for underpayments, complete with links to their just-as-confusing Form 2210.
2) Your tax advisor. (Cue confetti falling from ceiling and music)
Download HAR's Tax Organizer!
Oh you know how we like go the extra mile :) Below is a beauteous Tax Organizer to help you get your ducks in a row. The form includes travel-agent specific categories from general office expenses, to travel expenses. Take a look (then download below!)
That Wasn't So Bad, Was It?
I'm not a tax expert but I am a business owner that wished I'd had a guide to navigate estimated taxes my first time around! So, while I'm waiting for the snow to melt here in Minnesota, I decided to write up a guide on estimated taxes—I hope it helped! If it did, I'd love it if you'd give it a like/share or share your experiences below. If you've found this article helpful, I think you might really like our newsletter! Join 13,451 agents and sign up for our monthly newsletter and learn more about starting and growing your travel agency. * Bonus: My dog is in every newsletter dressed as an astronaut, because he's really cute.