Paying for something you could have avoided is one of the worst feelings in the world. From incurring overdraft fees to missing a payment when you swear autopay was all set up, preventable charges are something no one likes to deal with. For 1099 contractors and small business owners, this same frustration hits on a much larger scale if your estimated quarterly tax payments aren’t paid properly. This is known as the estimated tax trap, and it’s a doozy.
What Are Estimated Taxes?
Estimated taxes are pretty much exactly what they sound like. These are taxes that most non-W2 and “other income” folks must pay to offset the federal and state income that would otherwise be withheld throughout the year by a traditional employer. The IRS expects your estimated annual taxes to be split into four payments paid throughout the year.
Can I Just Pay Annually?
If you’re required to make quarterly payments on your taxes, it’s important that you do that. If you don’t, well… you may have noticed that the IRS isn’t quite the forgiving type. They expect you to make payments by the dates they expect them, or there are penalties that accrue… and accrue. Here’s the worst part: you likely won’t even know it’s happening until the end of the year!
Think of it this way: if you’ve ever had the misfortune of getting disqualified in a track and field race, the tax penalty works kind of like that. Instead of stopping the race and causing a big disruption, they’ll let you finish with all the others. But with causes for disqualification that can be as minor as a step or two in another lane, you may only find out as you cross the finish line that you’ve been out of the running two laps ago.
Would’ve been nice to know before you ran that extra ½ mile, right?
Similarly, the IRS isn’t going to let you know that you owe quarterly payments until the end of the year. Which would be fine if they didn’t charge you interest over that whole time period, but they do.
What Can I Do to Stay On Top of My Estimated Tax Payments?
Fortunately, there are several ways you can be proactive and save yourself the anxiety of an unexpected tax penalty.
1. Get Educated
First, you should look into whether estimated tax payments actually apply to your situation. This rule is income based, so if you don’t expect to owe above $1,000 for the year, you may not be required to file quarterly.
There are a variety of tax estimator tools for contractors and small businesses. Enter your information to get an idea of how much you can expect to pay quarterly.
2. Set Aside a Percentage
The name of the game here is preparation. Having calculated what you expect to owe, start setting aside money each quarter so that you don’t get blindsided.
The standard payment deadlines for estimated taxes are on the 15th day of January, June, April, and September. Plan accordingly.
3. Track Your Write-Offs
While most small business owners are aware that they can write off their business expenses, many contractors who just start to pick up a higher volume of work are not.
Business expense write-offs are a great opportunity to lower your quarterly payments in most contracting and small business scenarios. Let’s say you bought a laptop to provide some remote writing services. This will probably qualify as a business write-off. Did you travel to and from work sites as a handyman? Keep a record of all these things so that you can prove your expenses and enter them against the amount you owe.
4. Consult an Advisor
If you have any questions about what you owe, what you can write off, or just want an expert in your corner, working with a financial advisor or CPA is the best way to ensure you get all the money you deserve.
But Wait… There May Be An Upside!
Making quarterly estimated tax payments sounds daunting at first, and it certainly can be if you don’t stay on top of it. That said, it’s a small price to pay for being your own boss. And since you are your own boss, it’s not a bad thing to become more intimately aware of the state of your finances.
Making quarterly estimated tax payments will push you to remain vigilant around your projections and operational costs. And with a little know-how and planning, paying quarterly contracting taxes can be very manageable.
If you are a business owner, particularly in the service sector with a Point-of-Service (POS) system in place, there’s a great app to automate your sales tax: DAVO Sales Tax. As a business owner you are already wearing plenty of hats, so make it easy on yourself by automating the collections.
Planning your estimated monthly tax payments is a big part of keeping your head above water as a contractor or small business. If you would like to ensure your payments are as low as possible, give us a call at K Wealth Advisors today. We’ll be more than happy to schedule a GoodFit meeting to discuss your goals and options. #KWA