Wage earners have taxes withheld from their paychecks. Child care providers and other self-employed persons with a positive income are required to make estimated tax payments. Otherwise, an underpayment penalty may show up on your income tax return, which is calculated on Form 2210 (instructions). To avoid the underpayment penalty, you generally must make quarterly payments during the year. Total payments must equal the lesser of 100% of your total federal tax for the prior year or 90% of what you actually end up owing for the current year. This is why they call it "estimated tax." You estimate what you will owe and send it in. Or you can fall back on the "safe harbor rule" and calculate payments based on your prior year federal tax. (Note that for higher income taxpayers - generally above $150,000 - the safe harbor percentage goes up to 110% of the prior year tax.) This is not necessary to make estimated tax payments if you expect your business to show a loss for the year--meaning that you expect your business expenses to be greater than your child care income. Married providers can avoid making payments if their spouse has enough income tax withheld from his paycheck to cover their joint income tax. If you haven't made any payments yet this year or have missed payments, it's never too late to catch up and at least pay something. ... If you make no payments, the IRS figures your underpayment penalty using a tax rate of 3.571%. If they expect you to pay $1,000 each quarter and you pay nothing, your underpayment is $4,000 and your underpayment penalty will be $143 ($4,000 x .03571). If you make some, but not all, of the expected quarterly payments, you will owe something less. Even if you pay $1,000 for each quarter, you can still get hit with an underpayment penalty if you miss the quarterly due dates and pay late. In the above example, the underpayment penalty is not huge, but it all depends on the amount you should be paying. If you have a high income from your day care business, you could face much a higher penalty. Note that the underpayment penalty is different from late payment penalty which applies when you pay your tax return balance due after April 15. The late payment penalty at 0.5% per month is higher than the underpayment penalty. Unfortunately, I find that business owners who find it impossible to make their estimated tax payments very often cannot pay the tax by April 15 either and so the penalties multiply. I know that many folks are struggling right now, but if you don't make it a priority to set aside enough of your income during the year to pay your taxes, you are digging a hole that guarantees worse financial struggles in the future. Think about it. Your business is unlikely to bring in enough money next year to cover two year's worth of taxes, and you can easily fall several years behind if you are not making estimated tax payments. I remember the struggles I had in starting my tax business and understand how hard it can be, but the truth is that your business is not sustainable if you don't get current in paying your taxes. That means making quarterly payments every year. When I work with clients who have a tax balance due with the filing of their income tax return, I suggest that they set up an IRS installment agreement (using Form 9465) and pay that bill off over time. That way, they can make the current year estimated tax payments their first priority and break the cycle of owing every April 15. Using this approach, they can have the peace of mind that comes with being completely current with Uncle Sam, once the installment agreement is paid off. You will probably need the help of a tax professional in calculating your estimated tax payments, but you can also estimate on your own or even just pick an amount and send it in. Paying something is always better than paying nothing. If you pay in more than you ultimately owe, you will get a refund. If you pay less than you owe, you will pay the difference when filing your income tax return. At tax time, I ask clients to estimate the amount of child care income they expect to receive in the coming year. Then I make some corresponding adjustments to their expenses, calculate the resulting tax, and set them up to pay a certain amount every quarter. State estimated tax payments may also be required. During the year, quarterly payment can be increased or decreased, as necessary. This is particularly important if a day care provider's income is increasing. If you bring a new child into your program, you should probably increase your remaining payments. Child care income is subject to both income tax and self-employment tax, so every dollar of additional income has the potential to increase your tax significantly. If you a lose a child, on the other hand, you are in a position to decrease remaining quarterly payments. Estimated tax payments are due quarterly and that's the best way to pay to avoid penalties. But be aware that you can make an estimated tax payment any time, using Form 1040-ES payment voucher 1, 2, 3, or 4, and in whatever dollar amount you want. Do be sure to use a voucher showing the correct year, though, and keep a record of the amounts and the dates that you mail your payments. Scroll to the end of the Form 1040-ES document to find the payment vouchers and mailing addresses. You can type your information into the vouchers and print them. I recommend you also save an electronic copy as a PDF file. IMPORTANT: Always to write your social security number on your check, as well as "Form 1040-ES" and the year for which you are making payments.
Last updated 3 December 2009
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