289 - Your quarterly taxes are due

On today's episode of the podcast I'm breaking down why you need to pay quarterly taxes and how to calculate what you owe.

Trying a new format for the podcast today,  I'm sharing Chapter 5 from my Unf*ck Your Biz audio book to help you understand quarterly taxes and also, being totally transparent with you, to sell more copies of my book, with you can get at unfuckyourbizbook.com 

If you're looking for help on how to pay your quarterly estimated taxes, I created the Quarterly Quickie, a $10 guide on how to pay which you can get at www.notavglaw.com/quickie. 

When we become self-employed, we become responsible for our own taxes by paying them as quarterly estimated taxes. It uses the time value concept of money.  A dollar today is worth more than it is in the future and we want our money now (and so does the IRS). Much like how you run your business,  you wouldn't accept your client payments at the end of the year, and the IRS wants their money when you owe it, not at the end of the year because they have expenses too. 

Much like you don’t have to drive the speed limit, you don’t have to pay quarterly taxes, but it will come with a penalty. If you expect to owe $1,000+ in tax for the year and you expect your withholding and refundable credits to be less than the smaller of either 90% of the tax to be shown on your return or 100% of the tax shown on your prior return when the prior return covers the whole year, then you must pay quarterly taxes. 

For example, Greg in his second year of business makes $20,000 in his part-time garage business. He also gets a salary from his full-time job. He owes tax of $10,000 on his total income. Greg has $7,000 withheld from his paycheck for his full-time job. In his first year of business he owed $8,000 in taxes. Apply the first part of the rule, Does Greg owe at least $1,000 in tax? Yes. He owes $10,000. 

Now apply the second rule, which has two parts. Part one: What would 90% of the tax due be? Here, Greg’s tax due is $10,000. 90% of that would be $9,000. Part two: What was the total tax due for the prior year? Here, Greg’s tax due in the prior year was $8,000. The lessor of those two parts is $8,000. Now, ask whether the amount withheld was less than $8,000. Greg had $7,000 withheld, which is less than $8,000. He must make quarterly tax payments. If Greg had $8,000 withheld, he would not be required to pay quarterly tax (but it would still be advisable for him to set aside the appropriate percentage of his income to eventually pay the tax).

The IRS has a few tax penalties that range in amount with the primary penalties being 1) Late payment and 2) Late filing. You may initially think the late-payment penalty serves to charge penalties when you fail to pay taxes before April 15th (or October 15th if you file an extension)  but that’s only partially true. If you’re required to pay quarterly taxes, then the penalties start to accrue after the deadline if you fail to pay. The penalty for failure to pay quarterly taxes is far less than almost all forms of consumer debt which is why I always share that it’s never worth going into personal debt in order to pay your quarterly taxes though I encourage you to not play games with your quarterlies unless absolutely necessary. 

Business owners tell themselves, “I’ll take care of that when I’m making more.” But every time we get more money, we get normalized to it. We increase our spending and nothing really changes. This cycle is a big part of why I created the Unf*ck Your Biz Framework. 

How to Estimate Your Quarterly Taxes:

1. Estimate income and divide into three buckets - net self-employment income, employment income, and other income. If you’re married, include the total of both your and your spouse’s income in each category.

2. Find total and taxable income. To find taxable income we subtract adjustments, the qualified business income deduction, and the standard or itemized deductions. If you’re not sure if you have any adjustments or itemized deductions, deduct your standard deduction to start

3. Calculate income tax. Make sure to do a search for the tax brackets applicable to the year in which you’re calculating.

4. Calculate self-employment tax on each of your three buckets.

5. Add up your total from steps 3 and 4.

6. Subtract credits. If you have children, don’t overlook the child tax credit.

7. Find Federal tax percentage. Find the effective tax rate for federal taxes. To do that, take a step back and find gross income (income before any expenses). Take the total income and add back in any expenses that had been deducted. From there, divide the total federal tax due by the gross income.

8. Calculate state tax percentage. Since we already calculated the federal percentage, you can figure the state percentage as one-fourth or one-fifth of that. If you’re in a flat tax state, the process is a bit different. You have to calculate the tax first and then figure the effective tax rate. If you’re in a state with no income tax, write 0.

9. Find your total tax percentage by adding your state percentage to your federal percentage.

This total percentage is how much of your gross business income you should be setting aside for taxes. Also, mentally note that your percentage may change as your total income increases or decreases. For example, if you were to cash out a trust or IRA, or you were to win some money or otherwise acquire more income (other than by gift), your income would increase. Not only do you need to pay tax on that income, but you need to consider that it will also increase your tax bracket, so you need to set aside more of your business income for quarterlies.

The more sources of income you have the more complex quarterly taxes are to estimate, especially when we bring spousal income into that. U.S. tax law allows married couples who were married for any part of the year to file as married filed jointly for the whole year.

You should now be able to answer the million dollar question: How much must I save for quarterly taxes? Not sure? Pick up your copy of the Unf*ck Your Biz book or get the audio book at unfuckyourbizbook.com