Tomorrow could be the last chance for these taxpayers to avoid a big tax penalty
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Small-business owners and side-gig hustlers are facing a major tax deadline.
Filers who pay estimated taxes every quarter, including independent contractors and partners in business entities, owe their final payment of 2020 on Jan. 15.
Generally, the other deadlines for quarterly taxpayers are April 15, June 15, and Sept. 15.
Last year was an extraordinary one from a tax-planning perspective, as the Treasury Department and IRS delayed the due dates for first- and second-quarter estimated payments to July 15.
Normally, employees don’t have to worry about quarterly payments. That’s because their employers typically withhold income taxes from their pay during the year.
Meanwhile, sole proprietors and other small businesses are responsible for paying their estimated self-employment taxes and income taxes four times a year.
“If you were getting income all year, the IRS will calculate what tax you should’ve owed quarter by quarter,” said Dina Pyron, global TaxChat leader at Ernst & Young.
When you fall short on your payments by the deadline, underpayment penalties begin to accrue.
Make accurate payments, avoid penalties
Generally, in order to avoid an underpayment penalty, you’ll have to pay at least 90% of the tax for the current year or 100% of the tax on your return for the prior year.
If your adjusted gross income on the previous year’s return exceeded $150,000, then you’ll need to pay 110% of the tax liability.
Those estimates can be thrown off by year-end surprises, including commissions and bonuses, which can inflate your income.
Small-business owners and many other quarterly taxpayers faced an uphill battle in 2020, as they not only grappled with dwindling incomes but were still on the hook for those quarterly payments, as well.
Some entrepreneurs had to make difficult choices through 2020 in order to get by.
“If you have a business that’s drastically affected by Covid-19, and you’re a sole proprietor and you owe quarterly estimates, you might have to pick between paying the estimate or keeping the cash in the business,” said Dan Herron, CPA and principal of Elemental Wealth Advisors in San Luis Obispo, California.
“You’re on the hook for those quarterly payments, but say your payment is $4,000,” he said. “What’s the opportunity cost of the $4,000, does it mean you stay in business another month? That’s the choice.”