Author, “Eat What You Kill,” CEO of Williams Accounting & Consulting and Suivant Consulting
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Small business owners often find themselves owing a large tax bill that they cannot afford to pay. It’s become common for them to have some sort of tax mishap early in their careers that involves owing a ridiculous amount of money to the IRS.
How does this happen? They fall into the estimated tax trap.
Most people would assume that these small business owners are simply not paying their taxes and the solution is to simply pay the IRS. In actuality, these businesses are paying their taxes; they’re just not following IRS guidelines on how to pay their taxes, which is how they fall into the estimated tax trap and accumulate tax debt.
It happens way too often and most of the time to businesses that believe their taxes are paid in full only to be blindsided by a hefty tax bill. And sometimes these huge tax bills are large enough to put them out of business.
The IRS has guidelines for estimated taxes regarding individuals and businesses, with separate rules for each and describing what to pay and how often an individual or business is required to pay it.
Normally, when an individual works for an employer, their employer withholds their income and payroll taxes. The employer eventually pays these taxes to the taxing authorities and provides them with a W-2, showing the amounts withheld. That’s how individuals are either eligible for a tax refund or owe only a small amount of taxes.
Since small business owners do not have their taxes withheld, they are required to make estimated tax payments to the tax authorities throughout the year. And this is how they get caught in the estimated tax trap.
Small business owners usually must pay estimated taxes on January 15, April 15, June 15 and September 15 of each year. This requirement falls upon sole proprietors, individuals receiving 1099s, S corporation shareholders, owners of LLCs that are treated as disregarded entities or taxed as partnerships and anyone else who is earning money but not having their taxes withheld.
The estimated tax amounts are often quite large because they include the individual’s federal income taxes (tax rates of 10% to 37%), state/municipal taxes (tax rates up to 13.3%) and, for self-employed individuals, self-employment taxes of 15.3%.
Many small business owners are not aware of their estimated tax obligations or a large amount of the payments when they start their business. And their ignorance of this system is how many of them end up paying taxes, believing that they’re up-to-date when in reality they’re further behind than they could ever imagine.
Even after they become aware of these obligations, they often fail to properly budget their funds to timely and fully make the estimated tax payments.
The IRS and state tax authorities do not notify small business owners of non-payments of the estimated taxes until after the year-end tax return has been filed. By then, it is too late, as they have already fallen into the estimated tax trap and owe a large tax bill with penalties and interest that they cannot afford to pay.
For those small business owners who have already fallen into the estimated tax trap, I advise them to find an accountant who can help get out of the trap by getting into an installment agreement and requesting an abatement of the accrued tax penalties.
Of course, the best approach for a small business owner is to work with an accountant upon business formation to make the required estimated tax payments and avoid falling into the estimated tax trap. It’s important that small business owners focus on making timely payments in full to order to avoid falling into the estimated tax trap.
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