Wage earners have taxes withheld from their paychecks. Child care providers and other self-employed persons pay current year taxes via quarterly estimated tax payments. Essentially, you estimate how much tax you will owe and send it in. If you make estimated tax payments that exceed the taxes you actually owe, you will receive a refund when you file your tax return.
An underpayment penalty may apply if you owe $1,000 or more on your federal tax return (or $500 or more on your California tax return) and estimated tax payments are not made. To avoid this penalty, total payments must equal -THE LESSER OF- 90% of what you actually end up owing for the current year -OR- 100% of your total tax for the prior year. (Note that for higher income taxpayers - generally above $150,000 - the prior year percentage increases to 110%.)
Calculating estimated tax payments should be part of your annual tax preparation process. New providers may wish to take Tom Copeland's suggestion and make federal estimated tax payments equal to 20% of gross income (parent fees plus Food Program income). New California providers might make state estimated tax payments equal to 5% of gross income. These percentages are just a rough (hopefully conservative) estimate of the first year taxes that will apply to your business profit.
Business profit means your gross business income minus allowable business and home-related expenses. If your business shows a loss for the year, no tax will apply.
Married providers can avoid making payments if the income tax withheld from their spouse's paycheck is enough to cover their joint income tax.
If you have missed payment due dates this year, you can catch up by paying something now.
To me the worst thing about skipping estimated tax payments is not the potential penalties. It is the fact that you are only putting off paying your taxes for the year. Make estimated taxes a high priority. Otherwise, you can easily find yourself with a large tax balance due at tax time. If you cannot pay your total tax by April 15, the penalties will really start to add up. This cycle can be hard to break.
It is all too easy to fall several years behind if you are not making estimated tax payments. Think about it. Your business is unlikely to bring in enough money next year to cover two years worth of taxes, right? I find it very painful sending in my quarterly payments, but a business is probably unsustainable if you are not staying current on tax payments.
When clients have a large tax balance due with the filing of their income tax return, I suggest that they set up an IRS installment agreement (online or using Form 9465). If you go this route, you can pay off your prior year tax bill over time. Make the monthly installment payment low enough that you can also make the current year quarterly estimated tax payments. This can break a cycle of big tax bills every April 15.
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 payments can be increased or decreased, as necessary. It is particularly important to pay attention if your 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 may be in a position to decrease remaining quarterly payments.
Here's how to make an estimated tax payment.
Last updated 15 May 2013