If you earn income from various sources throughout the year, such as equity windfalls, venture capital fund distributions, crypto investments, and sales, or small business income, you will need to pay estimated quarterly taxes. In this comprehensive guide, we’ll explain what estimated quarterly taxes are, how to calculate them, and provide guidance on how to pay them on time to avoid penalties and interest charges, ensuring that all target groups are well-equipped to manage their tax responsibilities.
Table of Contents
- What Are Estimated Quarterly Taxes?
- How To Calculate Your Estimated Quarterly Taxes
- Deadlines and How To Pay Quarterly Taxes
- Quarterly Taxes By Income Source
- Tax Penalties and Consequences of Underpayment
- Frequently Asked Questions
What Are Estimated Quarterly Taxes?
Estimated quarterly taxes are payments made to the Internal Revenue Service (IRS) on a quarterly basis to cover your tax liability when your income is not subject to withholding. This includes income from self-employment, investments, rental properties, and other sources.
If you expect to owe at least $1,000 in taxes for the year, you will need to make quarterly estimated tax payments to the IRS. Failing to make these payments on time can result in penalties and interest charges.
Making accurate and timely estimated tax payments helps you manage your taxable income, avoid penalties, and ensure you’re in compliance with the IRS.
How to Calculate Your Estimated Quarterly Taxes
To calculate your estimated quarterly taxes, you’ll need to estimate your total income for the year and subtract any deductions and credits. Then, you’ll need to calculate your expected tax liability and divide it by four to determine your quarterly payment amount.
For example, if you’re a self-employed freelancer, you’ll need to calculate your estimated tax payment based on your projected income for the year, your business expenses, and any deductions or credits you may be eligible for. You’ll also need to consider your self-employment tax obligations, which include both the employer and employee portions of Social Security and Medicare taxes. Because of the complexities of the tax code, make sure you work with a Harness Tax Advisor or other tax professional before making any payments.
Deadlines and How To Pay Quarterly Taxes
The deadlines for quarterly estimated tax payments for 2023 are:
- April 18th
- June 15th
- September 15th
- January 15th, 2024
If the due date falls on a weekend or holiday, the deadline is extended to the next business day.
To pay your quarterly taxes, use the IRS’s Direct Pay portal, or mail in your payment along with your completed Form 1040-ES.
It’s important to make your quarterly tax payments on time to avoid penalties and interest charges. It’s also a good idea to keep track of your payments and save any receipts or confirmation numbers as proof of payment and inform your Harness Tax Advisor or other tax professional.
Quarterly Taxes By Income Source
Equity Compensation
If you’re a startup employee who has received equity compensation in the form of stock options, Restricted Stock Units (RSUs), you may need to pay quarterly estimated taxes on any gains realized when you exercise or sell your shares. The amount of your tax liability will depend on factors like your income, the type of equity compensation, and the length of time you’ve held the shares. Additionally, if the income from your RSUs is under-withheld or not withheld, you may need to increase your quarterly estimated tax payments to cover your tax liability.
If you earn any income from an acquisition, Initial Public Offering (IPO), tender offer, or a secondary sale of your startup equity, you may also owe taxes on the capital gains. Use Form 1040-ES to calculate and pay estimated taxes on any equity compensation or sales.
When you exercise stock options, you may need to use Form 3921 to report the exercise of your Incentive Stock Options (ISOs) and Form 6251 to calculate any Alternative Minimum Tax (AMT) owed on the exercise of your ISOs. If you are granted RSUs, the value of the shares at the time of vesting is considered ordinary income and is subject to income taxes.
Crypto Investments
Crypto assets and cryptocurrency investments, as well as related activities including staking and lending, are all subject to capital gains tax and estimated quarterly taxes. Any time you sell, exchange, or use crypto to purchase goods or services, you may trigger a taxable event. Accurately tracking your crypto transactions and understanding the tax implications is crucial to staying compliant with the IRS.
Here are some additional points to consider:
- If you sell crypto for a profit, you may need to use Form 8949 to report the capital gains or losses from the sale. You’ll need to report the date of acquisition, the date of sale, the sales price, and the cost basis of the cryptocurrency.
- You may also need to use Schedule D (Form 1040) to report your overall capital gains and losses. This form summarizes your capital gains and losses for the year and calculates your net capital gain or loss.
- If you stake cryptocurrency, you’ll need to report the fair market value of the cryptocurrency as income on your tax return. This income is subject to income tax and self-employment tax if you’re a self-employed individual.
- DeFi activities, such as providing liquidity or participating in yield farming, may also generate taxable income that should be included when calculating estimated tax payments.
To calculate your estimated tax payments, you’ll need to estimate your total income for the year, including any income from crypto. You can use Form 1040-ES to calculate your estimated tax payments and make payments throughout the year to avoid underpayment penalties.
Properly calculating your capital gains, losses, and taxable income related to crypto investments can help ensure you pay the right amount of estimated quarterly taxes and avoid potential tax issues.
Venture Capital
Venture capital investors may receive income in the form of capital gains, dividends, or interest from their investments. This income may be subject to estimated quarterly tax payments. As a venture capital investor, it’s important to be aware of your tax obligations, including estimated quarterly tax payments. One tax document you may receive is a Schedule K-1 (Form 1065) from the partnership or LLC that you invested in.
While there are no quarterly payments owed specifically for K-1s, taxpayers who receive K-1s may need to make quarterly estimated tax payments if they expect to owe at least $1,000 in tax for the current tax year and if their withholding and refundable credits are less than the smaller of their total tax liability for the previous year or 90% of their current year’s tax liability.
If you receive a Schedule K-1 (Form 1065) from the partnership or LLC that you invested in, you may need to use this form to report your share of the income, deductions, and credits. You’ll also need to calculate your estimated tax payments based on your share of the income. Use Form 1040-ES to calculate and pay estimated taxes on VC investments.
One tax deduction to consider for those with venture capital investments is Qualified Small Business Stock (QSBS). This is a tax incentive that allows investors to exclude up to 100% of the gain on the sale of qualified small business stock held for more than five years. To qualify, the stock must be issued by a domestic C corporation with less than $50 million in gross assets and meet certain other requirements.
Self-Employed or Small Business Owners
Self-employed individuals and small business owners are typically required to make estimated quarterly tax payments, as their income is not subject to withholding. This includes sole proprietors, partners in a partnership, LLC members, and S-corporation shareholders. In addition to federal income tax, self-employed individuals must also pay self-employment tax, which covers Social Security and Medicare taxes.
Here are some additional points to consider:
- You’ll generally use Schedule C (Form 1040) to report your business income and expenses. This form is used to report your net profit or loss from your business.
- You may also need to use Schedule SE (Form 1040) to calculate self-employment tax and Form 1040-ES to calculate your estimated tax payments and make payments throughout the year to avoid underpayment penalties. Self-employment tax includes both the employer and employee portions of Social Security and Medicare taxes.
To provide a practical example, let’s say you’re a freelance product designer and you have several clients. You’ll need to keep track of your income and expenses and calculate your estimated tax payments accordingly. By understanding your business’s revenue, expenses, deductions, and credits, you can determine your taxable income and estimate your federal and state tax liability for the year. Making timely payments can help you avoid penalties and interest charges.
For small business owners or startup founders, one tax deduction to consider is the Research and Development (R&D) Tax Credit. This credit allows businesses to claim a tax credit for qualified research expenses, which can include wages, supplies, and contract research costs. To qualify, the research must be intended to develop or improve a product, process, or software.
Tax Penalties and Consequences of Underpayment
The penalty for underpayment of estimated tax is typically calculated at the current federal short-term interest rate plus 3 percentage points, and is assessed on a quarterly basis. For example, if you underpaid your estimated tax by $1,000 for the first quarter of the year and the federal short-term interest rate is 2%, the penalty would be $5 ($1,000 x 0.005 x 1 quarter).
In addition to the penalty for underpayment of estimated tax, you may also be subject to interest charges on the unpaid tax. The interest rate is determined quarterly and is generally the federal short-term interest rate plus 3 percentage points.
Safe Harbor Rule
You may be able to avoid underpayment penalties by following the Safe Harbor rule for estimated quarterly taxes. The Safe Harbor rule for estimated quarterly taxes means that if you meet certain criteria, you won’t be subject to underpayment penalties.
There are three parts to the Safe Harbor rule:
- If you expect to owe less than $1,000 after subtracting your withholding, you’re safe.
- If you pay 100% of your tax liability for the previous year via estimated quarterly tax payments, you’re safe.
- If your adjusted gross income for the previous year is more than $150,000 (or $75,000 if married and filing separately), you must pay 110% of your tax liability for the previous year to be safe
It’s important to note that the Safe Harbor rule is not a guarantee that you won’t owe any taxes at the end of the year – it simply means that you won’t be subject to underpayment penalties.
Frequently Asked Questions
1. How do I know if I need to make estimated quarterly tax payments?
If you expect to owe at least $1,000 in federal taxes for the year after subtracting your withholding and refundable credits, and if you expect your withholding and refundable credits to be less than the smaller of 90% of your tax liability for the current year or 100% of your tax liability for the previous year, you’ll need to make estimated quarterly tax payments.
2. What happens if I overpay my estimated quarterly taxes?
If you overpay your estimated quarterly taxes, you’ll receive a refund when you file your annual tax return. Alternatively, you can apply the overpayment to your next year’s estimated tax payments.
3. Can I adjust my estimated tax payments if my income changes during the year?
Yes, you can adjust your estimated tax payments during the year if your income, deductions, or credits change. This can help you avoid underpayment or overpayment penalties.
4. How do I account for state taxes when making estimated quarterly tax payments?
State tax requirements vary, so it’s important to research your state’s tax rules and consult with Harness Tax Advisor or other tax professional to ensure you’re making accurate estimated tax payments at both the federal and state levels.
For example, in California, you may need to make estimated quarterly tax payments if you expect to owe at least $500 in state taxes for the year after subtracting your withholding and refundable credits. In New York State, you may need to make estimated quarterly tax payments if you expect to owe at least $300 in state taxes for the year after subtracting your withholding and refundable credits.
5. Are there any exceptions to the estimated quarterly tax payment requirements?
There are some exceptions to the estimated tax payment requirements. For example, if you had no tax liability in the previous tax year, you may not be required to make estimated tax payments for the current year. Additionally, you don’t have to pay estimated tax for the current year if you meet all three of the following conditions: you had no tax liability for the prior year, you were a U.S. citizen or resident alien for the whole year, and your prior tax year covered a 12-month period
6. What if my income fluctuates throughout the year?
If your income fluctuates throughout the year, you may need to adjust your estimated tax payments accordingly. If your income for the previous tax year was $150,000 or less, it’s best to make sure all four estimated payments are equal to 100% of what you owed in taxes the previous year or 90% of what you expect to owe in the current year. If your income for the previous tax year was more than $150,000, you may need to pay 110% of what you owed in taxes the previous year to avoid underpayment penalties
Harness Wealth Can Help
Remember, paying quarterly taxes is just one part of managing your finances, and it’s important to have a comprehensive tax strategy that takes into account your complete financial goals and needs. If you earn income from startup equity, crypto, venture capital, or other sources, and need advice on how to best manage your tax liabilities and financial planning throughout the year, sign up for Harness Tax today.
Tax services provided through Harness Tax LLC. Harness Tax LLC is affiliated with Harness Wealth Advisers LLC, collectively referred to as “Harness Wealth”. Harness Wealth Advisers LLC is an internet investment adviser registered with the Securities and Exchange Commission (“SEC”). Harness Wealth Advisers LLC solely acts as a paid promoter for unaffiliated registered investment advisers. Harness Wealth Advisers LLC’s registration as an investment adviser with the SEC does not imply a certain level of skill or training.
Risks Relating to Digital Assets: There are certain risks relating to digital assets, virtual currencies, cryptocurrencies and/or digital coins/tokens (collectively, “Digital Assets”). The investment characteristics of Digital Assets generally differ from those of traditional securities, currencies, commodities. Digital Assets are not backed by a central bank or a national, international organization, any hard assets, human capital, or other form of credit and are relatively new to the marketplace. Rather, Digital Assets are market-based; a Digital Asset’s value is determined by (and fluctuates often, according to) supply and demand factors, its adoption in the traditional commerce channels, and/or the value that various market participants place on it through their mutual agreement or transactions. The lack of history to these types of investments entail certain unknown risks, are very speculative and are not appropriate for all investors.
