NEWS & RESOURCES

Authored by: Kyle Meissner, CPA, Financial Advisor

Understanding Estimated Tax Payments and Self-Employment Tax

If you’re new to running your own business, filing your tax return might come with some unexpected surprises. Unlike employees who have taxes withheld from their paychecks throughout the year, self-employed individuals must handle tax obligations on their own. One of the biggest considerations for business owners is self-employment tax, which is an additional tax on top of ordinary income taxes. Additionally, many business owners must make quarterly estimated tax payments to avoid IRS penalties.

Self-Employment Tax: What You Need to Know

When you earn income from a sole proprietorship, you are responsible for paying both income tax and self-employment tax. Self-employment tax covers Social Security and Medicare contributions that are typically withheld from wages for employees. For self-employed individuals, this tax rate is 16.2%, which can significantly impact the amount owed at tax time.

Considering S-Corporation Tax Status

If your business generates substantial profits, you might explore electing to file as an S-Corporation. Unlike sole proprietorships, where all business income is subject to self-employment tax, S-Corporations allow business owners to structure income differently:

1. The business must file its own tax return separately from personal taxes.
2. The owner must pay themselves a reasonable wage, which is subject to self-employment tax.
3. Any remaining profits distributed to the owner are not subject to self-employment tax.

While S-Corporations can reduce self-employment tax, they come with additional accounting and legal complexities, including payroll management and corporate filings. The decision to elect S-Corporation status should be carefully weighed based on individual business needs and tax savings.

Estimated Tax Payments: Avoiding IRS Penalties

The IRS requires self-employed individuals to make quarterly estimated tax payments if they expect to owe more than $1,000 in taxes. Without employer withholding, these payments ensure taxes are paid throughout the year rather than all at once.

Quarterly Payment Deadlines

Estimated tax payments are due on:

• April 15 (for income earned January–March)
• June 15 (for income earned April–May)
• September 15 (for income earned June–August)
• January 15 (of the following year, for income earned September–December)

To calculate these payments, self-employed individuals should estimate income tax liability based on their taxable income and add the 16.2% self-employment tax.

Consequences of Not Paying Estimated Taxes

Failing to make estimated tax payments can result in IRS penalties, particularly if the previous year’s tax liability exceeded the amount paid in quarterly taxes. The IRS may assess underpayment penalties, which can add unnecessary costs to your tax bill.

Key Considerations for Business Owners

Self-employed individuals must take proactive steps to manage tax obligations:

• Determine whether S-Corporation status could reduce self-employment tax burdens.
• Set aside funds for quarterly estimated tax payments to avoid surprises at tax time.
• Keep detailed financial records to calculate tax liabilities accurately.
• Consult a tax professional to ensure compliance with IRS requirements and explore tax-saving strategies.

By understanding self-employment tax and estimated tax payments, business owners can minimize tax-related stress, avoid penalties, and make informed decisions about their financial future. Taking control of tax planning early ensures a smooth experience when filing returns and managing business finances effectively.

At Cordell, Neher & Company, PLLC, we provide expert guidance on self-employment tax strategies and estimated tax payment planning to help business owners minimize tax burdens and stay compliant with IRS regulations. Contact us at cnccpa.com or call (509) 663-1661. We’re here to provide you with a complete financial team in your corner.