The pay-as-you-go idea
The tax system expects payment throughout the year, not in one lump at filing time. Self-employed people usually meet this by sending quarterly estimated payments covering both income tax and self-employment tax. If too little is paid on time, a penalty can apply even when the full bill is paid at filing.
The payment dates are not always evenly spaced and can shift for weekends and holidays. Always confirm them on the IRS site for the year in question.
How owners usually estimate
There are two common approaches. One is to project this year's profit and compute the tax. The other is to base payments on last year's tax, which can be simpler. The IRS describes the conditions in which either avoids penalty, and the rules depend on income level. Ask your preparer which approach suits you.
A bookkeeper can supply the year-to-date profit and loss at each quarter end. That report is the raw input to any estimate.
Using your books at each quarter
Close the books for the quarter first. Reconcile the accounts, so profit is real and not inflated by missing expenses or deflated by duplicates. Then print the year-to-date profit and loss and send it to your preparer or use it with the IRS worksheet.
If income is seasonal, say so. A business that earns most of its profit in the fall should not assume each quarter looks the same, and some methods allow for uneven income.
Record every payment carefully
Each federal estimated payment should be saved with the date, amount and the confirmation number. Record it in the books as an owner draw or a tax payment in equity, not as a business expense, because it is a personal tax payment for a sole proprietor or similar owner.
State estimated payments follow the same logic with their own rules. Keep a separate line for each. At filing, the preparer will ask for the total of all payments and will want the amounts to match what the IRS shows on your account.
If you fall behind
Missing a payment does not mean giving up. Make the next payment, pay more if you can, and discuss it with your preparer. Penalties are generally calculated by period, so catching up quickly limits the damage. Do not wait for filing season to find out.
If you also have a job with withholding, ask whether adjusting your withholding there is easier than making quarterly payments.
Common misunderstandings
Some owners believe a refund last year means no payments this year. That is not how it works when income comes without withholding. Others believe the penalty only applies if you owe a lot. The calculation is by period and by shortfall, so a small shortfall in one quarter can still produce a charge.
Another trap is treating a good month as the new normal. Revenue spikes may not repeat, so check the year-to-date picture, not just the latest month.
Worked example with numbers
An owner expects to net $60,000 for the year and her preparer suggests setting aside 25%. That is $15,000 for the year, or $3,750 per quarter. After each quarter, she compares the actual profit to her estimate and adjusts the remaining payments.
Record each payment as an owner draw or tax payment, not as a business expense, because estimated taxes are not deductible expenses of the business.
Mistakes that cost money
Believing the bank balance is profit. Paying once a year. Deducting estimated payments. Using last year's number without checking.
Check your work
Check due dates with the IRS and your state each year.
Common questions
Are estimated tax payments a business expense?
For sole proprietors and similar owners, no. They are payments toward the owner's personal tax and belong in equity or a tax payment account.
Do corporations pay estimated tax too?
Corporations that owe tax generally pay in installments as well, under their own rules. Ask your CPA.
This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.