paying quarterly estimated taxes

[Weemery]

I'm about to go independent as an LLC and will pay quarterly taxes. Do I have to pay an actual estimated pre-determined amount based on 100% of last years income or can I simply pay the ACTUAL taxes due based on my income. I'm getting paid quarterly, so figuring the tax is pretty simple. The payment will be different each quarter, but with the online payment system does it matter?Weemery, CFP.

[Bradly T.]

Paying prior year's amount is a "safe harbor" to protect from penalties (not interest) but the actual tax due is the actual tax due so paying quarterly based on income should be sufficient....unless it's not. Going forward, you can use safe harbor rule but a rising income would suggest continuation of your current plan.

[Tad Borek]

Weemery, there are two issues - paying the tax, and avoiding penalties.

You avoid penalties by meeting one of three "safe harbors": through estimates and withholding, pay 1) 100% of prior-year tax (higher if your AGI is high), or 2) 90% of current-year tax, or 3) end up owing less than $1,000. The forms and worksheets for estimated taxes explain all this.

You normally do these estimates evenly throughout they year, but if your income is uneven you can avoid the penalty by making sure your payments are on track each quarter, and then filling out the horrendous annualized income installment method Form 2210, which is in effect four mini tax returns (one for each quarter).

Don't forget about self-employment tax, which is 15.3% of your first dollar earned up to the SS wage base (see form 1040 SE). And you may need to do this exercise for your state too, and it may have different rules about how you make payments (e.g. CA).

Note that you may still end up owing money in April, which is a budget issue...the safe harbors are just to avoid penalty for not sending in enough tax ahead of time. It's good to have a good estimate of your net income from the business in early January to get ready for that.

And after you're done write it all up and be ready to talk about it with clients! Major cash-flow issue for the self-employed; they're notorious for forgetting about estimated taxes and in particular, the self-employment tax which quickly runs way into the thousands (an April surprise, for those who have never heard of it).

-Tad

[Weemery]

Thank you for the helpful responses. I think my 2012 income will be roughly the same (perhaps slightly lower than 2011), so I'll use 100% of last year and make even quarterly payments.
I am most definitley a supporter of The Fair Tax, or similar tax reformation plan.



UGH!!!

Weemery, CFP.