If you own a pass-through entity (limited liability entity or S corporation), your non-wage income earned through the business is subject to quarterly estimated tax payments. The timing and amount of those payments are subject to a complicated set of rules. Here is what you need to know.
When to pay?
The IRS calendar is a bit unusual. Your first quarter payment is due on April 15th, inconvenient timing given that this is also the date that any remaining taxes owed for the previous year are due. It is very important that you budget for this double whammy, because underpayment or nonpayment of either prior year taxes or first quarter taxes can result in penalties.
The remaining due dates are as follows:
- Second Quarter – June 15th
- Third Quarter – September 15th
- Fourth Quarter – January 15th
If any of these dates fall on a holiday or weekend, then the tax is due on the next business day. Also note that if you pay these taxes electronically, the payment may need to be initiated the day before the due date to ensure timely withdrawal from your account.
How much to pay?
The IRS has two options for calculating how much to pay each quarter, one based on your prior year tax liability and the other based on the current year. If your income was less than $150,000 in the prior year ($75,000 for single taxpayers), then paying 100% of your prior year tax in equal installments will be sufficient to avoid an underpayment penalty. If you made more than $150,000, then you are required to pay in 110% of last year’s tax.
Alternately, you may opt to pay in 90% of your current year tax liability in quarterly installments. This method requires a bit more work because you have to estimate your income tax liability at each quarterly milestone date and pay an amount sufficient to cover at least 90% of that amount. A miscalculation can result in a penalty, although it should be noted that the IRS underpayment penalty rate is quite low.
In neither circumstance can you pay your entire tax liability in the fourth quarter and expect to avoid penalties. In other words, both methods require that you pay as you go. Finally, the Alabama estimated tax rules are consistent with the Federal rules; therefore, you can use the same methodology to determine how much you need to pay the state.