An estimated taxes death spiral can result when taxpayers fail to pay their estimated taxes, then delay filing a return, which can result in growing penalties and interest, and may adversely affect their personal and business life.
For example, without tax returns, it may not be possible to apply for a home mortgage or a business loan. And when no tax return is filed, the IRS can assess accumulating interest and penalties on top of any back taxes.
Here are some strategies that may help you avoid falling into this trap.
Fund Your Tax Payments
Perhaps the biggest reason for not paying estimated taxes may be simply lacking the money to do so. Business owners who have cash flow concerns can often use money coming in to pay the bills and may not think about future estimated tax needs.
How can you stay cognizant of the ongoing need to pay estimated taxes? Consider saving money for this purpose. Try to save enough to at least protect you from any underpayment penalties, which require you to pay at least 90 percent of your current year’s actual liability or 100 percent of the prior year’s liability (110 percent if your adjusted gross income in the prior year was more than $150,000, or $75,000 if married filing separately). These penalty safe harbors are explained in IRS Publication 505.
If you lack the discipline to save, consider making payments automatic. For example, you could schedule weekly or monthly transfers from one bank account into a special account set up solely for paying estimated taxes.
Remember to Make Payments
Even though there are four annual payments, the due dates are not in quarterly intervals, and the dates can easily slip by. The dates are April 15, June 15, September 15 and January 15 or, if those dates fall on a weekend or a holiday, the next closest business day.
Noting the due date on your calendar is one way to remember to remit your payments. Other ways:
- Schedule automatic payments through EFTPS.gov. This is a free online payment system that allows you to schedule payments 365 days in advance.
- Delegate payment reminders to your accountant. Many business owners use CPAs to prepare their business and personal returns. Ask your tax advisor to prompt you to make your payments on time.
Keep the Big Tax Picture in Mind
Estimated taxes must cover your income taxes: federal and, where applicable, state and local. If you're an owner in a pass-through entity—a partnership, limited liability company (LLC) or S corporation—take into account your share of the business’s income that passes through to you. Also include in estimated taxes:
- Self-employment tax if you're self-employed. Self-employed individuals are sole proprietors, general partners and members in limited liability companies. Independent contractors, such as freelancers, Uber drivers and others receiving Form 1099-MISC reporting “non-employee compensation,” are also subject to self-employment tax.
- Additional Medicare and Social Security taxes. If you work for yourself, you are also responsible for paying Medicare taxes on your income. In 2017, the rate is 1.45 percent, according to the Society for Human Resources Management. The exact percentages can shift year-to-year. Social Security taxes are capped, with sole proprietors paying a percent up to a certain amount of income—in 2017, the cap is $127,200. But Medicare taxes have no cap, so no matter how much you earn, you will need to pay a percentage of your income.
- Other taxes. These include alternative minimum tax (AMT) if it's greater than your regular tax and any employment taxes on household employees (e.g., a nanny or home health aide).
Make sure your savings to pay estimated taxes covers all types of tax liability to which you are subject.
You can possibly avoid the need to pay estimated taxes if you increase income tax withholding to cover your projected tax bill. To do this, there must be a paycheck to serve as the source for withholding. Here are two options:
- Increase withholding from a spouse’s paycheck. A self-employed individual whose spouse is an employee can address the couple’s tax bill through the spouse’s withholding (assuming he or she is amenable to this).
- Change your business’s entity. If you own an unincorporated business, consider incorporating so you become subject to withholding on earnings disbursed to you as salary. If you own an LLC, you can elect to be treated as a corporation and make an election to be taxed as an S corporation (assuming the business is eligible to be an S corporation); you receive a paycheck and become subject to withholding from this source. No change in business status is needed; only a tax election is made.
While you may be focused on filing your tax return for this year, it's also time to think about estimated taxes you'll be filing next year. It may be helpful for new business owners who have never paid estimated taxes to work with a tax professional to get started on the right foot. Seasoned business owners may also use professionals to help determine the extent of estimated payments needed to avoid penalties. Consider doing whatever it takes to avoid the estimated taxes death spiral.
For more tips on how to help ease your way through tax season, access our exclusive guide, It’s Tax Time: A Business Owner’s Survival Guide.
The information contained in this article is for generalized informational and educational purposes only and is not designed to substitute for, or replace, a professional opinion about any particular business or situation or judgment about the risks or appropriateness of any financial or business strategy or approach for any specific business or situation. THIS ARTICLE IS NOT A SUBSTITUTE FOR PROFESSIONAL ADVICE. The views and opinions expressed in authored articles on OPEN Forum represent the opinion of their author and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions (including, without limitation, American Express OPEN). American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any opinion, advice or statement made in this article.
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A version of this article was originally published on February 22, 2016.