Start your own business this year? Avoid the estimated tax trap.

Our US Federal income tax system works on a pay-as-you-go basis.  As you earn income, you must pay taxes (sorry).  Therefore, April 15 is not the “due date” for your tax payments.  Rather, April 15 is the date by which you must “square out” with the feds.  In your tax return, due April 15, you figure out the real taxes due.  If you already paid more than that throughout the year, you will get a refund.  If you paid less than that throughout the year, then you need to pay up the difference.  State income taxes work the same way.

If you are self-employed and expect to earn more than $1,000 for the year, then you are probably required to pay estimated taxes.  Every three months, you must estimate your total income for the year, estimate taxes on that income, and then  pay a percentage of it.  Click here for more details.  Estimated taxes can be especially problematic for first-year entrepreneurs and consultants.  They might work all year long, completely oblivious of taxes.  In February or March of the next year, a tax bill arrives for as much as one-third of their income!  Suddenly they must come up with tens of thousands of dollars.  And there could be penalties, too.

Benjamin Franklin said, “In this world nothing can be said to be certain, except death and taxes.”

If you are required to pay estimated taxes, plan carefully for them.