Estimated Taxes for Business Owners: Due Dates, Safe Harbors, and How to Calculate

Employees have tax withheld from each paycheck. Owners of sole proprietorships, partnerships, and S-corps typically have profit that no one withholds tax on, so the responsibility falls to them. Estimated taxes are the mechanism, and they are one of the most common sources of surprise bills and penalties for new business owners.

Who needs to pay

Generally, you must make estimated tax payments if you expect to owe at least $1,000 in tax for the year after subtracting withholding and credits, and your withholding and credits are expected to be less than the required annual payment (the smaller of 90 percent of the current year tax or 100 percent of the prior year tax, with the higher percentage for higher earners). This covers:

Sole proprietors and single-member LLC owners (income tax and self-employment tax).
Partners and LLC members (their share of profit).
S-corp shareholders (tax on pass-through income beyond wages that have withholding).
People with significant investment or rental income.

C-corporations pay their own estimated taxes separately. See C-corps for small business.

The four due dates

For calendar-year taxpayers, the payment periods and due dates are generally:

First quarter: April 15 (income earned January 1 to March 31).
Second quarter: June 15 (April 1 to May 31).
Third quarter: September 15 (June 1 to August 31).
Fourth quarter: January 15 of the following year (September 1 to December 31).

The periods are not equal quarters, which surprises many owners. When a due date falls on a weekend or holiday, it moves to the next business day. Some states have different due dates. Check your state.

Safe harbor rules

You generally avoid the underpayment penalty if you pay through withholding and estimates at least the smaller of:

90 percent of the tax shown on this year's return, or
100 percent of the tax shown on last year's return (if last year was a full 12-month year), or 110 percent if your prior year adjusted gross income exceeded $150,000 ($75,000 if married filing separately).

The prior-year safe harbor is popular because it gives certainty: pay 100 or 110 percent of last year's total tax in four equal installments and you avoid penalties, even if this year's income is much higher. You still owe the balance when you file. The current-year method makes sense if income dropped and you want to pay less. See the small business tax calendar for reminders.

Also exempt: if you owe less than $1,000 after credits and withholding, or if you had no tax liability last year and were a U.S. citizen or resident for the full year.

Calculating the payments

Use Form 1040-ES, which includes a worksheet. Steps:

Estimate adjusted gross income for the year, including business profit, other income, and adjustments (like half of self-employment tax and retirement contributions).
Subtract deductions (standard or itemized, and the QBI deduction if it applies).
Compute income tax using current rates.
Add self-employment tax. See self-employment tax explained.
Subtract credits and withholding.
Divide by four for equal payments, or use the annualized income installment method if income is uneven.

Software and tax professionals can automate this. If your income is stable, base payments on last year's return with adjustments.

The annualized income method

If your income is lumpy, the annualized income installment method lets you pay based on the income earned through each period rather than assuming equal income. It can reduce or eliminate penalties for owners with seasonal or back-loaded income. It requires computing on Form 2210 Schedule AI and keeping records by period.

S-corp owners

An S-corp owner's wages are subject to withholding, so payroll withholding contributes to the safe harbor. Because withholding is treated as paid evenly through the year, regardless of when it happened, a year-end increase in withholding (for example, through a bonus with additional withholding) can be a way to catch up on tax without penalty, unlike estimated payments which are dated when paid. That is a nuance worth discussing with your adviser. The pass-through profit beyond wages still requires estimated payments or extra withholding. See S-corp distributions explained.

Practical cash management

Set aside a percentage of revenue or profit each month in a separate tax account. A typical starting point is based on last year's effective tax rate plus a cushion. See business bank account setup.
Pay through the IRS's online payment options or Direct Pay, or use the Electronic Federal Tax Payment System, and keep confirmations.
Adjust after each quarter by comparing actual profit to your estimate.
Pay state estimates if your state has an income tax, separately from federal.
Do not skip a quarter because you lack cash. Penalties accrue based on the amount and time underpaid.

Penalties

The underpayment penalty is essentially interest on the amount you should have paid by each due date, at a rate tied to federal short-term rates plus a margin. It is computed on Form 2210. You can request a waiver in narrow circumstances (casualty, disaster, retirement after age 62, or disability). Paying late is better than not at all.

Changes during the year

If a big sale, a new client, a loss of a client, or a new hire changes your income, recalculate. Also recalculate after major changes in structure, such as an S-corp election or a large equipment purchase that changes deductions. See when to elect S-corp status.

State and local estimates

Most states with income taxes require estimated payments with similar rules but different due dates or forms. Entities that make pass-through entity tax payments have their own deadlines. See pass-through entity tax.

Common mistakes

Assuming no payments are needed until filing.
Using equal quarters for uneven income without checking the annualized method.
Forgetting self-employment tax in the estimate.
Treating the due dates as quarter ends, and missing June 15 and January 15.
Not paying state estimates.
Paying the entire tax in the fourth quarter and paying penalties for earlier quarters.
Using last year's number when last year was unusually low and then facing a large balance due.
Spending the tax money.

A simple system

Transfer 25 to 35 percent of net profit (adjust to your situation) to a tax savings account each month. Pay the safe harbor amount each quarter from that account. At year end, top up based on actual results. Review quarterly with your bookkeeper or tax adviser.

For help calculating estimates and choosing safe harbor methods, AE Tax Advisors can assist, and a discovery call is a good first step.