It’s strange to be writing this in July, but Happy Tax Week! Hopefully everyone got their returns (or extensions) in by Wednesday as required. Since taxes are fresh on most of our minds, I want to discuss a sticky little subject that I frequently see mistakes on: estimated tax payments.
Not surprisingly, the IRS wants their share of your earnings and they want it now. This usually isn’t a big deal for W2 employees, who have a corresponding amount of taxes taken out with each pay check. But for S-Corp and LLC owners, this gets a little trickier because regular wages don’t reflect all of the income attributable to you through your practice. And chances are, you should be paying estimated tax payments.
In a nutshell, the IRS says you have to meet a minimum threshold of tax payments on income earned throughout the year or face interest and penalties (5% in the first half of 2020, which has dropped to 3% for the 3rd quarter).
A quick note on this: I’ve heard many doctors say they just elect to pay the penalty because it’s so small, but consider this: if you do have a real dispute or issue with the IRS, one of the factors they consider is payment history. So if you have a history of not paying your estimated taxes, that could affect their willingness to work with you.
There are two components to estimated tax payments: how much you have to pay and when they’re due.
Disclosure: since S-Corps and LLCs are pass through entities to the individual owners, I’m referring to personal estimated tax payments in all of these scenarios. Also, MOST states that have an income tax follow the same rules as the IRS, but you should check with your CPA on your specific domicile.
How much do you have to pay in estimated taxes?
The rules on estimated tax payments are really simple: you have to pay taxes throughout the year that equal one of two amounts:
1- 100% of last year’s tax bill
2- 90% of the current year’s tax bill
For growing practices, paying last year’s bill is a no-brainer. It’s also the easiest formula since it’s backward-looking and doesn’t require regular check-ins on how your practice is performing.
Hopefully no practices are on a steady decline, but for those, OR PRACTICES THAT EXPECT TO BE DOWN BECAUSE OF COVID-19, it may be worth calculating regularly how much you owe based on actual income, especially in a time when your practice might be cash strapped.
You should be looking at your P&L regularly no matter what, so it should be easy to do a quick calculation on your estimated tax bill. Just make sure to have your CPA review your 12/31 financials before the January payment to account for tax-adjusted line items such as meals and travel.
When (calendar-wise) to pay estimated taxes
Normally (and I know we’re all hoping we’re back to normal sooner rather than later) estimated taxes are due 4 times per year:
- April 15
- June 15
- September 15
- January 15
This year, these payments have been changed to just September 15th and January 15th since filing was extended to July (you can’t pay 100% of last year’s tax bill if you don’t know what it was!).
As a business owner who has to pay estimated taxes myself, I suggest either writing the 4 checks in advance and keeping them handy with a calendar reminder OR creating and auto-payment from your bank or accounting software.
Remember, staying in good graces with the IRS is always good idea for business owners!
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