The Ultimate Guide to Estimated Taxes (Form 1040-ES)

A common question I receive from small business owners is “how do I calculate my quarterly tax payments?” At the heart of this question is the fear of ending up like Al Capone. I hope to alleviate those fears and provide you with this ultimate guide to estimated taxes.

First, what are estimated taxes? Estimated taxes are payments of tax on income that is not subject to withholding. The most common types of income that are not subject to withholding are self-employment income, business income, rental income, and investment income.

Am I required to make estimated tax payments? You may be required to make estimated tax payments if you expect to owe over $1,000 in federal taxes after subtracting out federal tax withholding and credits.

Is there a difference between “ES taxes” and “Estimated Taxes”? Nope! They are the same. Sometimes estimated taxes are referred to as “ES” taxes because individuals would send payment with Form 1040-ES.

When are estimated taxes due? Estimated taxes are due in four installments, usually on the following dates:

  • 1st Quarter – April 15
  • 2nd Quarter – June 15
  • 3rd Quarter – September 15
  • 4th Quarter – January 15

Does the IRS have to receive my payment by the due date if I mail my check with Form 1040-ES? Nope! The IRS will consider your payment timely if postmarked by the due date.

How do I calculate estimated taxes? I like to break estimated tax calculations into two categories – safe-harbor calculations or actual calculations. The safe harbor provision states that as long as you pay 100% of the prior year tax liability (110%, if your AGI was >$150,000 in the prior year) or 90% of the current year tax, you can likely avoid any penalty on potential under payment. While you may owe additional tax come April 15th, this makes ES calculations much more simple!

Where do I find my prior year Adjusted Gross Income (AGI)? Your adjusted gross income can be found on Form 1040, Line 37 (for 2015).

Where do I find the total tax paid last year? The total tax paid in the previous year can be found on Form 1040, Line 63 (for 2015)

I’m still confused about this safe-harbor non-sense, elaborate! If you expect income (and therefore taxes) to increase year after year, you can simply take last years total tax, subtract out any year-to-date withholding (your spouses withholding from their job as an employee, for instance), and divide by 4.

Here’s an example: Last year, the total tax on Line 63 was $40,000. You work freelance and your spouse works as employee. Your spouse’s federal income tax withholding on their paycheck for the current year is $2,500/month or $30,000 for the year. Your business is growing, and just by looking at your financials on QuickBooks you see that you are on pace to increase net profit by 20% for the year! You know that you will owe more in tax, but you would prefer to hold on to the money for short-term capital needs or an equipment purchase, so you decide to make a safe harbor payment. Since your AGI was greater than $150,000 for the prior year, you will need to have a minimum of $44,000 ($40,000 x 110%) of federal taxes paid in for the current year to avoid penalty.  We subtract the amount your spouse will have in withholding, and arrive at $14,000 ($44,000 “safeharbor” tax that needs to be paid in at a minimum, less $30,000 estimated withholding from your spouses paycheck). We divide the $14,000 by 4, to arrive at $3,500. We will make four $3,500 tax deposits by each quarterly due date. Please note, this doesn’t necessarily mean you won’t owe any additional tax at the year of the year, but it does mean you will not owe any interest or penalty for underpayment of taxes.

I know it’s not that easy, do you have any other resources with examples? Okay, maybe your right, maybe estimated taxes are a little more complex than I am making them out to be. The IRS does try to simplify the process and put out instructions and resources on the topic. Estimated tax worksheets and instructions from the IRS website can be found here.

When should I use the safe-harbor provisions and when should I do an actual estimate? I recommend using the prior year tax safe-harbor calculation if you expect taxes to increase from the prior year. The current year safe harbor (90% of the current year tax) is ideal for individuals that may have had a high paying job prior to becoming a consultant or self-employed, and expect their tax liability to decrease significantly. Occasionally, we will calculate an actual tax due amount – if a client has a large unusual transaction, such as a investment property disposal, a large stock transaction, option exercise, or company exit OR if the individual prefers to not owe any tax at the end of the year.

What about Self-Employment taxes? Yikes! The dreaded self-employment tax. If you are subject to the self-employment tax, and want to use the current year safe harbor (paying 90% of the current year tax, as opposed to 100/110% of the prior year tax), refer to the worksheets on the IRS website previously mentioned.

How do I make estimated tax payments? You can make estimated tax payments by mailing Form 1040-ES with a check, using DirectPay on the IRS website, or EFTPS with the Treasury Department.

Do you have any other tips? That’s all I have for now – if you have questions, feel free to leave them in the comments!

If this post was helpful, feel free to share it with your friends! Since quarterlies are often overlooked, individuals sometimes end up paying penalties or interest that could have been easily avoided. Why give the IRS any more than you have to?

 

 

The Sharing Economy & How It Impacts You

The IRS recently launched a new resource center on IRS.gov aimed at providing tips for individuals that are taking part in the sharing economy. The past few years, the sharing economy has changed the way people travel, commute, and vacation. With new streams of revenue from assets that individuals already possess, come new requirements to ensure individuals file accurate tax returns.

The IRS, working in conjunction with the National Taxpayer Advocate, is taking steps to provide additional information to taxpayers, including the creation of the new Sharing Economy Resource Center on IRS.gov.

To help people meet their tax reporting responsibilities, the new Sharing Economy Resource Center offers tips and resources on a variety of topics ranging from filing requirements and making quarterly estimated tax payments to self-employment taxes and special rules for reporting vacation home rentals.

Here are a few key points people involved in the sharing economy should keep in mind:

  • Taxes. Income received is generally taxable, even if the recipient does not receive a Form 1099, W-2 or some other income statement. This is true if the sharing economy activity is only part-time or a sideline business and even if the recipient is paid in cash. On the other hand, depending upon the circumstances, some or all business expenses may be deductible.
  • Deductions. There are some simplified options available for deducting many business expenses for those who qualify. For example, a person who uses his or her car for business often qualifies to claim the standard mileage rate, currently 54 cents a mile for 2016.
  • Rentals. Special rules generally apply to the rental of a home, apartment or other dwelling unit that is used by the taxpayer as a residence during the taxable year. Usually, rental income must be reported in full, any expenses need to be divided between personal and business purposes and special deduction limits apply. But if the dwelling unit is rented out fewer than 15 days during the year, none of the rental income is reportable and none of the rental expenses are deductible.
  • Estimated Payments. The U.S. tax system is pay-as-you-go, based on the wherewithal to pay. This means that people involved in the sharing economy often need to make estimated tax payments during the year to cover their tax obligation. These payments are due on April 15, June 15, Sept. 15 and Jan. 15. Use Form 1040-ES to figure these payments.
  • Payment Options. The fastest and easiest way to make estimated tax payments is to do so electronically using IRS Direct Pay or the Treasury Department’s Electronic Federal Tax Payment System (EFTPS).
  • Withholding. Alternatively, people involved in the sharing economy who are employees at another job can often avoid needing to make estimated tax payments by having more tax withheld from their paychecks. File Form W-4 with the employer to request additional withholding. The Withholding Calculator on IRS.gov can also be a helpful resource.

If you have any questions about how the sharing economy may impact your taxes, feel free to contact our office.

 

Five reasons you should open a Health Savings Account Now!

We’ll save you some time and start off by saying, HSA’s only benefit individuals and families who are in a high deductible health insurance plans (HDHP), not enrolled in Medicare, and are not claimed as a dependent on someone else’s return. If you are in one of these HDHP’s, keep reading, because HSA’s are the perfect vehicle to save you money on taxes and stretch your medical spending. Here’s why:

  1. Pre-Tax Earnings: Contributions are typically pre-tax. Meaning, if your employer makes a contribution to your HSA, it’s not included in your gross taxable income.
  2. Tax write-off: Contributions can be made towards a HSA up until April 15 after the close of the previous tax year. These contributions can be used as a deduction on your tax return, saving you money on taxes. For example, if you are in the 25% tax bracket, a maximum family contribution of $6,750 (for 2016) to an HSA can save you up to $1,687.50 in taxes! Individuals 55 or older can make “catch-up” contributions; these catch-up payments increase the contribution limits by $1,000 for even greater tax savings.
  3. Tax-Free Earnings: Any interest or income earned on the assets in your HSA are earned tax-free, even upon taking the money out to pay for qualified medical expenses. Different banks will allow for and offer different types of investments, so be sure to do your research.
  4. Roll-Overs: Funds in your HSA roll-over from one year to another, meaning you don’t “use it or lose it” like Flexible Spending Accounts (FSAs).
  5. Portable and transferable: Not only can you transfer a HSA from one bank to another or from a previous employer to a new employer, you can also use an HSA like an IRA. If an HSA participant has a balance upon death, the balance of the HSA can be inherited tax-free by a spouse named as a beneficiary on the account. For non-spouse individuals, the HSA ceases to be a HSA and the balance is included at the fair market value on the date of death as taxable income to the person who inherits the account. This is similar to the treatment of a traditional IRA that has been inherited and liquidated.

If you have any questions about HSA’s and how they can benefit you from a tax perspective, feel free to contact our office.

Three Qualified Medical Expenses that are sure to surprise you!

While digging though past court cases and IRS memos, we found these three surprising instances where medical deductions were allowed for not-so medical expenses:

  1. Mis-lead – A taxpayer, who’s child who was treated for lead poisoning, was allowed a medical expense deduction for the costs associated with scraping and removing lead paint from the taxpayer’s home.
  2. A deduction for man’s best friend? – The IRS considers the costs associated with buying, training, and maintaining a guide dog to assist a visually impaired, hearing impaired, or persons with other physical disabilities, a medical expense. This includes costs such as food, grooming, and veterinary care incurred in maintaining the health and vitality of the service animal so that it may perform its duties.
  3. Refreshing news – The IRS has allowed medical deductions for the costs associated with installing swimming pools as long as the pool was directly related to medical care and specially designed for medical purposes. Some of the diseases that were covered in previous cases included osteoarthritis, emphysema, bronchitis, and degenerative spinal problems among others.

Moral of the story – the are some strange deductions out there! If you have questions about the deductible nature of specific expenses, contact our office so we can research your situation further.

Summertime brings Scammers

There has been an increase in IRS phone and email scams in recent months. Please be on the lookout and remember:

  • An IRS agent will never call about money owed without first mailing you a bill
  • An IRS agent will never ask for a credit card, debit card, or prepaid card information over the phone
  • An IRS agent will never threaten to bring in local police or other agencies to arrest you for non-payment

Contact with the IRS will almost always be initiated through official correspondence in the mail, not over the phone. Be sure to keep your address current with the IRS and don’t be a victim! If you are contacted via email or by phone and you don’t owe taxes or have no reason to think that you owe any taxes, then call and report the incident to TIGTA at 1-800-366-4484. More information on recent scams can be found on the IRS website.

Three Tips for Starting a Business

When starting a business, understanding your tax obligation is one key to business success. With the internet and the wealth of information found on the web, it’s easy to be misinformed. Hopefully this post will clear up any questions or concerns you may have when starting your business.

  1. Business Structure. One of the first decisions you will make when starting a business is deciding on a business structure. Business structures can have a huge impact on the tax liability of your operations, therefore it is always best to seek council from a CPA or lawyer. The most common forms of businesses are:
    • Sole Proprietorships
    • Partnerships
    • Corporations
    • S-Corporations
    • Limited Liability Company (LLC)
      • There are many misconceptions surrounding the LLC as a business structure.
      • Here are the facts: An LLC is a business structure that is allowed by state statute. Each state has it’s own statutes regarding the requirements for ownership. An LLC has default treatments for federal taxation that may only be changed by timely filing the correct elections. The default treatments are as follows:
        • An LLC with one member (whether individual or another business) is disregarded for federal tax purposes (but still a separate entity for employment taxes and excise taxes)
        • An LLC with two or more members is by default a partnership
      • If an LLC would like to elect a treatment other than the default, it can do so by filing Form 8832 or Form 2553. An LLC can elect to be treated as a Corporation or S-Corporation. An LLC is NOT by default, either of these entities.
  2. Business Taxes. There are four general types of taxes that businesses pay:
    • Income Tax – All business except partnerships must file an annual income tax return. Partnerships, however, file an information return.
    • Self-Employment Taxes -these are social security and medicare taxes primarily levied on individuals who work for themselves (examples would include sole proprietors, single member LLC’s where an individual is the sole owner, and in some cases, partnerships)
    • Employment Taxes – businesses with employees have a responsibility to pay and file forms related to social security taxes, medicare taxes, federal income taxes, and federal unemployment (FUTA) taxes.
    • Excise Taxes – some businesses may be required to pay excise taxes, more information on these taxes can be found on the IRS website.
  3. Employer ID Number (EIN). An EIN or Federal Tax Identification Number is used to identify a business entity. Most businesses can apply for an EIN on the IRS website free of charge. An EIN is recommended, even for sole-proprietors, to obtain a bank account and provide to vendors who may request tax information.

If you have any questions about entity selection or getting your business Launched!, feel free to contact our office or schedule a consulting meeting.