Understanding Self-Employment Taxes

Why do I need to estimate taxes?

As a business owner, you need to pay estimated taxes because your income tax is not automatically withheld from your earnings throughout the year. While W-2 employees have their taxes withheld by their employer, self-employed child care business owners are responsible for paying their taxes directly from their earnings, and you must do so by the timeline and schedule set by the IRS.

Example

Let's say you earned $8,000 in your child care business during the first quarter of the year. Without estimated taxes, you might not have paid any taxes on this income until the following April, when you’ll be responsible for the tax bill for the entire year and face potential penalties for late payment. Estimating your taxes and making regular payments helps you distribute the tax burden and more accurately understand your personal financial position throughout the year.

How do I pay my estimated taxes?

Estimated taxes are typically paid in four equal installments throughout the year, aligning with the quarterly due dates. Before making payments, use the worksheets available on Form 1040-ES to help you calculate your estimated tax liability for your child care business. Be sure to include any relevant deductions that can reduce your overall tax liability, including using the time/space calculation if you are a home-based business. You can even use your previous year’s return to help estimate your income, deductions, and tax liability.

Child care providers have various methods for paying estimated taxes through the IRS. You can make your payments using any of the following methods:

1. Online through the IRS website using your bank account or your debit/credit card. No fees apply to payments made through your bank account and you can schedule payments up to one year in advance. For payments made with a debit/credit card, you can choose from the IRS’s three payment processors which can be taken online or on the phone.

2. Online through the Electronic Federal Tax Payment System (EFTPS). This system, managed by the U.S. Treasury Department, allows you to make online or phone payments 24/7. You must enroll online or by phone using a two-step verification process. Once enrolled, you can securely make payments or schedule them in advance.

3. By mail using a check, money order, or cashier’s check. When you pay by mail, you must include the Form 1040-V, or payment voucher, which includes detailed instructions for how to prepare your payment. It is important to note that the IRS does not accept cash payments by mail.

When do I make my estimated tax payments?

Understanding the quarterly payment deadlines is essential for child care providers. The IRS publishes an online tax calendar and offers calendar reminders to help you keep on top of your payment schedule.

Quarterly due dates for estimated tax payments are:

1. April 15th (for income earned from January 1st to March 31st).

2. June 15th (for income earned from April 1st to May 31st).

3. September 15th (for income earned from June 1st to August 31st).

4. January 15th of the following year (for income earned from September 1st to December 31st).

These quarterly payments are considered estimates because you are paying taxes on your assumed income for the year. However, your business may have varying rates of cash flow and profit or loss throughout the year. You can calculate your estimated taxes each quarter based on your estimated annual earnings, ensuring your estimated tax payments align with your actual income and cash flow. To determine your estimated annual profit, review your cash flow and profit and loss. Subtract your expenses from your revenue, the resulting number is your profit. Consider the following example:

Then, you can multiply that number by your estimated tax rate (15.3) to find your estimated tax payment and divide that number by four to find the estimated amount per quarter.

If you have made tax payments prior to completing this calculation, subtract that payment from your calculated amount to find the estimated taxes remaining. This can be done proactively with estimated figures to help you manage your finances effectively and mitigate a hefty tax bill at year-end. By being aware of your quarter tax amount, you can plan for that as an expense in your budget and reduce the risk of underpaying your taxes.

Another way to relieve the financial burden of your self-employment taxes is to make more frequent withholdings and payments. You can pay your estimated taxes weekly, biweekly, monthly, or at whatever frequency makes the most sense for your business, so long as you are paying your full estimated tax bill by each quarter’s deadline.

If your income fluctuates throughout the year, you can avoid or lower penalties by annualizing your income, meaning that you will calculate the total amount of money you will earn in the year, and make unequal payments based on your cash flow each quarter. This allows your quarterly taxes to be based on your annual income, but not place undue stress on your business during lower-earning quarters. You can use this form created by the IRS to see if there may be a potential penalty for underpaying. If you are concerned about penalties, make this review part of your quarter tax prep routine to reduce risk and stay accurately informed about what is owed.

Are there penalties for not paying taxes on time?

Failure to pay estimated taxes on time can lead to penalties. The IRS can impose penalties if you underpay your estimated taxes throughout the year. These penalties are calculated based on the underpaid amount and how late the payments were made.

Example

If you were required to pay $1,500 in estimated taxes for the first quarter of the year but only paid $1,200, you may face a penalty on the $300 underpayment.

Avoiding penalties can be done in four simple steps:

1. Complete Form 1040-ES as accurately as possible to estimate your business income and self-employed estimated tax liability.

2. Set aside money from your income on a regular basis, just like an employer withholds taxes from paychecks for W-2 employees. This withholding can happen at whatever frequency makes sense for your business – weekly, biweekly, monthly, or quarterly.

3. Pay your quarterly estimated tax bill in full before each quarter’s deadline. Put these deadlines on your calendar so you don’t miss them. If you prefer not to pay a lump sum once a quarter, you can pay more frequently using the money you set aside from your earnings. If you are mailing the payments, remember to add a small buffer to ensure the payments arrive on time.

4. If your estimated income changes throughout the year, you can complete another Form 1040-ES to get more accurate estimates as you progress through the year. Do this at least once per quarter if your income is different from what you expected, to ensure you are not underpaying on taxes.

If you are unsure if you owe penalties, complete Form 2210 to see if you need to file with the IRS for underpayment. If you are concerned about underpayment, penalties, or if you are accurately estimated your taxes, seek professional tax advice.

Conclusion

Self-employment tax and estimated taxes are vital considerations for child care business owners. By understanding these concepts, accurately estimating your tax liability, and making timely payments, you can successfully navigate your tax responsibilities. Seek guidance from a tax professional or refer to IRS resources and forms if you need assistance. Managing your taxes effectively will ensure you stay compliant with the IRS and avoid unnecessary penalties and stress on your business.