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Estimating Taxes: How Much Do I Have to Pay?

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Estimating Taxes: How Much Do I Have to Pay?

Estimating Taxes: How Much Do I Have to Pay?

As this year ends, we reflect on how we can improve in future years, such as ensuring that your estimated taxes are calculated and paid every quarter. Since it is already the end of the year, if your business still needs to pay in estimated taxes, we recommend doing so to get a headstart since this is considered a prepayment.

What is Taxable Income and How Income Is Made?

Businesses and 1099 Contractors earn taxable income, which is not automatically taxed. However, W2 employees receive a paycheck through payroll software, which allows withholdings for taxes to be automatically calculated. When the employer withholds the income taxes, they are generally paid every month, which decreases the employee’s tax liability at the end of the year if the W4 is filled out correctly.

Businesses and contractors are not so lucky to have this timely pay automatically calculated for them. Throughout the year, the business accumulates income as its net income. The number to be tracked for tax purposes is net profitability. Net profitability is your income after all deductible expenses have been subtracted from gross income.

Business Structure and Taxes

Business structure matters. An LLC, partnership, S-Corp Election, or C-corporation all have different guidelines on tax rates and taxes that have to be paid. Business location also determines how much tax liability will be accrued from the net income. Since location matters so much, we will focus on the federal side of the tax world.

What are your options with this information, and what should you do regarding estimated federal taxes? To start, if you are any tax entity besides an S-corp or C-corp, then you will be taxed income taxes for net income and self-employment taxes.

Let’s define self-employment tax. Per the IRS, self-employment tax is a flat rate of 15.3%, broken into two parts. 12.4% is for social security, while 2.9% is for Medicare. There are no deductions for this tax.

Reducing Your Tax Liability

Tax deductions are a complex and widespread factor. There are many different deductions, such as child tax credits, energy efficiency credits, and other personal deductions. These deductions are based on your company structure and how the income flows into your taxes, which leads to a critical point.

The business does not owe taxes unless it is a C-corporation. All other companies are passthrough entities, and the income is passed on to the personal tax return. In the future, we will write another blog and YouTube video on the differences between income and self-employment taxes since it’s a vast topic that will need more explanation than a snippet in this estimated tax blog.

Estimated Taxes are a Requirement

The federal government requires that tax liabilities be paid promptly. W2 employees are paid by their employers every month. However, this includes individual income from selling a house or stocks.

Most of this blog will focus on businesses, as our clients mostly face, but any income outside of a W2 is not taxed automatically and must be paid on time. Even if you draw on a retirement account like IRA, you are not getting automatic taxes withheld.

All of the above examples are the reasons that estimated tax payments exist beyond businesses. The IRS has set guidelines that say the prior quarter should be paid by the 15th of the following month.

The estimated payment should be a reasonable amount based on taxable money. To find that reasonable amount, we look at how much money was earned throughout the quarter and calculate the tax burden on that net income.

Why should you do this before getting your tax bill at the end of the year? You can do that, but it will cause you to pay more taxes.

There are no legal implications, such as jail time or lawsuits by the government. However, penalties and interest accumulate on your net income if you do not make a timely estimated tax payment. Why should you defer a tax burden you must pay in the long run anyway?

So, How Do You Calculate Tax Burdens?

The estimated tax calculation is finicky because business owners lack consistent monthly income. This is especially true for contractors because industries like HVAC are very cyclical. They will be busier and have increased revenue in the summer compared to the winter. This will make estimated taxes tricky because different quarters reflect different income levels.

We have two options for calculating the estimated tax payments for these cyclical industries. The first option is to base the estimated tax payments on the quarter’s net income. To calculate the tax burden rate, we recommend reviewing last year’s taxes if there have been no significant changes and basing your estimated payment on the tax burden you previously incurred.

The other option is to look more specifically at individual deductions and other income to get a more accurate picture of your tax burden beyond just the business income.

Finding the Correct Partnership to Explain

When looking for an accountant to help you with taxes, you should be looking for someone who wants to do more than sit down at the end of the year to file taxes. They should be willing and able to sit down quarterly to ensure you save the most money possible while preparing you for the upcoming year-end tax bill.

Working with an accountant like Waterford Business Solutions, you can take everything a step further. There is the ability to do tax planning, which reviews your specific situations and quarterly income. This can account for personal deductions and other types of income, such as W-2, to calculate a more exact estimated payment.

We currently offer our clients tax planning through a software called TaxPlanner Pro. Tax Planner Pro lets us integrate with QuickBooks to seamlessly pull income from the client’s books while adding a client profile for personal deductions. There are even options to run scenarios in a simulator to adjust income, W-2 income, estimated payments, and extra deductions to small details like cash donations.

This is a great reason to partner with an accountant for bookkeeping or tax filing and to prepare with tax planning throughout the year.

Even with the tax planning software options, it is still an estimate. The accuracy may be less than 100%, but we have seen close forecasts for our clients with this software. There are a lot of factors that go into calculating estimated taxes. Reviewing prior years may also assist with estimation when paired with the tax software.

If you take nothing else away from this blog, please make a quarterly estimated payment. Hence, you are not unnecessarily paying interest and penalties to the IRS simply because you missed a deadline.

You can give us a call at 864-351-0852 or email us at info@waterfordbusiness.com, and we’ll be happy to assist you, discuss any issues you may be having, and see how we can make your business better tax-prepared.

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Estimating Taxes: How Much Do I Have to Pay?