Nobody looks forward to paying taxes, but it’s less painful when tax withholdings are calculated by an employer and automatically withheld from your pay. Much easier than crunching the numbers ourselves and then paying the government out of our savings. Somehow, the latter process feels like we’re working for Uncle Sam, and that’s not a pleasant feeling.

Here in the United States, ours is a pay-as-you-go tax system, meaning we taxpayers are expected and required to pay taxes on our income as we earn it — instead of paying it all at once at the end of the year. Employees have taxes automatically withheld from their paychecks by their employers, which satisfies the taxing authority’s requirement.

In contrast, if you’re a small-business owner, you face the onerous task of calculating your income and expenses, estimating the amount of tax owed on that amount, and cutting checks (or making electronic payments) for the amounts due to state and federal entities. These include the Franchise Tax Board here in California, and/or the Internal Revenue Service (IRS). And, you’re required to repeat this process four times a year, to pay your businesses quarterly estimated federal, state, and local taxes.

No one wants to get stuck with a huge tax bill (and penalties) at the end of the year. Nor do we want to overpay, which is essentially giving the government a free loan while leaving ourselves and our business with less of the money we earned. As small-business owners ourselves, we at Stees Walker & Company, LLP, feel your pain, so in this part of our Small Business Guide to Reducing Your Tax Burden Legally — the 11th in our 12-part series — we lead you through the process of estimating your taxes, hopefully making it a little less painful. But first, we need cover a few preliminary topics.

Understanding Tax Withholdings and Estimated Taxes

According to the IRS, “Taxes must be paid as you earn or receive income during the year, either through withholding or estimated tax payments.” Withholdings are taxes an employer collects on behalf of the taxing authorities and sends to them on behalf of the employee. Estimated taxes are generally those paid quarterly based on a business entity’s expected business income. Taxpayers are required to pay estimated taxes in the following situations:

• The amount of income tax withheld from your salary or pension is not enough.
• You receive additional income such as interest, dividends, alimony, self-employment income, capital gains (for example, from selling stock for a profit), prizes, and awards from which taxes have not been withheld.
• You are in business for yourself, in which case the estimated taxes you pay cover not only the income tax you owe but also self-employment tax and alternative minimum tax (if applicable).

If you don’t pay enough tax through withholding and estimated tax payments, you may be charged interest, calculated weekly, on what you should have paid. You also may be charged interest if your estimated tax payments are late, even if you are due a refund when you file your tax return.

To avoid having to pay interest, you must deposit a certain minimum amount by the end of the year: Continue reading…