5 Estimated Tax Strategies for Business Owners

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Most business owners don’t have withholding from a paycheck to cover their income tax bill for the year. Even the paychecks of S corporation owner-employees may not be large enough to allow for withholding to cover taxes due on their share of profits. Estimated taxes, which work as a substitute for withholding, usually are necessary for most business owners. With the second estimated tax payment for 2011 due June 15th, you should review your tax payment amounts and procedures to avoid penalties or overpayments as well as to simplify the payment process.

Figure Estimates Properly

The goal of estimated taxes is to approximate the tax liability that will be figured when the 2011 income tax return is completed next year. Pay too little and you’ll owe penalties; pay too much and you’ll have made an interest-free loan to the government.

Estimated taxes must cover:

• Income taxes. This includes your share of business profits;
• Self-employment taxes. If you’re self-employed, self-employment tax is comprised of Social Security and Medicare taxes on your net earnings from self-employment.

Rely on Safe Harbor Rules

You can avoid any penalties for underpaying estimated taxes by relying on certain safe harbors.

Prior Year Safe Harbor

If you anticipate that your income for 2011 will be the same or greater than it was in 2010, then fix this year’s estimated tax payments based on last year’s tax liability – the amount of tax reported on the 2010 income tax return. This is called the 100% prior year safe harbor. Of course, if you discover that you’re short when you complete your 2011 return next year, you’ll have to come up with the money to pay what you owe, but at least you won’t owe any penalties, no matter how large the shortfall.

If your adjusted gross income (AGI) in 2010 was more than $150,000 ($75,000 if you were married and filed a separate return), then you’ll have to set your 2011 estimates at 110% of your 2010 taxes to avoid penalties. For example, if you’re single and paid $20,000 in taxes on your 2010 return and expect 2011 to be a better year than last year, set your estimated taxes for 2011 at $20,000 (or $22,000 if your AGI in 2010 was more than $150,000).

Current Year Safe Harbor

Instead of basing your payments on last year’s taxes, you’ll avoid penalties if payments for the current year are at least 90% of what you ultimately owe. This method is preferable if you expect this year’s taxes to be lower than last year’s. Thus, if you expect to owe $20,000 in taxes and you pay at least $18,000 in estimated taxes, you’ll escape penalties.

Other Safety Nets

There are other ways in which to figure estimated taxes in order to avoid penalties. These are explained in IRS Publication 505, Tax Withholding and Estimated Tax.

Use Set-Asides to Ensure Sufficient Funds

One of the key reasons some owners fail to pay required estimated taxes is lack of cash. Make sure you have enough money on hand when needed. One way to do this is to set up a separate account for estimated tax purposes. Create a schedule to use for putting money into this account — weekly, monthly, etc — and stick to it.

Make Payments Online

Business owners may be too busy to remember the estimated tax payment dates or may be traveling away from home at these times. To ensure that a payment won’t be late or overlooked, use the Electronic Federal Tax Payment System (EFTPS). You can schedule payments up to a year in advance. There is no charge by the government for using this payment method (check with your bank regarding any fees it may charge for electronic transfers). Using EFTPS.gov does not give the IRS access to the funds in your bank account or any authority to tap them for any reason.

Charge Payments to Your Credit Card

If you lack sufficient funds to pay estimated taxes and want to avoid late payment penalties, consider charging your payment to a major credit card. While the IRS and U.S. Treasury do not charge any fee for paying taxes this way, the IRS-approved card processor charges a “convenience fee” of between 1.95% and 2.35% of the amount charged (there’s a flat dollar amount imposed for using debit cards instead of credit cards).

To charge tax payments, go to:

• Official Payments Corporation
• Links2Gov Corporation
• RBS World Pay, Inc.

Final Word

Work with your accountant or other financial advisor to ensure that you meet estimated tax responsibilities. In some situations, it may make sense to incorporate a sole proprietorship or other non-corporate business in order to create wages for owner-employees. These wages, if sufficient, can be used as a withholding source to cover the tax obligations of owner-employees and avoid the need to make any estimated tax payments in the future.