How to Calculate Quarterly Taxes
We’re smack dab in the middle of tax season and as more business owners use YNAB to manage their small business budgets, I think it’s important to specifically address how to calculate quarterly taxes.
Taxes are one of the largest (and most confusing) infrequent expenses you have as a business owner, and getting yourself in tax trouble can literally bankrupt you. The key to staying one step ahead of the IRS is two-fold: have an organized system for tracking your taxable income and tax deductions and budget for your quarterly estimated tax payments on a monthly basis.
In the early days of YNAB, I ran the business budget of YNAB using…YNAB. It just made sense. Let’s take a quick trip back in time to check out the budget categories I used for YNAB the business.
The most notable one for this post is called Quarterlies, and it sits in the “non-YNAB” master category. The reason it’s under “non-YNAB” is because the business doesn’t pay the taxes; I, Jesse the individual, do. So a tax payment outflow is not an expense, it’s a distribution to me that goes directly to the Tax Man.
What Are Quarterly Taxes?
When you earn a paycheck, your taxes are withheld and sent to the Tax Man automatically. After you file your tax return, you end up getting a refund, or owing some more, based on how your total tax liability calculates.
Thanks to side hustles and/or entrepreneurship, some of you earn money in lieu of, or in addition to, a paycheck. Your state and federal taxes on that income aren’t withheld automatically. You need to do the withholding yourself, and will need to pay your estimated taxes each quarter.
How to Calculate Quarterly Taxes
When it comes to estimating what you’ll be required to pay, you should really ask your tax advisor. They’ll basically give you a set percentage of your profits to withhold. You could look back at prior tax returns to get an idea but if your business income has changed significantly from one year to the next, your estimate may be off. A quick rule of thumb: if the business is doing better, you’ll want to withhold a higher percentage. Again though, this percentage can’t be from the hip (been there, done that, no thanks on doing it again). As always, it’s better to err on the side of saving “too much”—then the only surprise is having money left over when it’s all said and done.
For our example, let’s say our agreed upon percentage is 25 percent. (I’m purposely avoiding going complex with the percentage calculation, because every single reader of this post will have a different, very specific scenario.)
How to Prepare for Estimated Taxes with YNAB
One of the Four Rules of YNAB is Rule Two: Embrace Your True Expenses, and there’s no truer expense than taxes. Ignoring them won’t make them go away (quite the opposite, in fact), so let’s learn to live with them instead. The easiest way to do this is to break these large sums of money into manageable monthly chunks in our budget.
Armed with a percentage of profits to be withheld for taxes, it’d look something like this in your YNAB budget:
Let’s say you just wrapped up your books for the month, have reconciled your accounts, and want to see how profits shook out. You’d click on Reports and choose Income v. Expense, find the month column, and look at the “Net Income” number at the very bottom. You see that profits for the month were $8,000. A quick calculation (8000 x .25) reveals that your estimated contribution towards quarterly taxes that month would be $2000.
You’d then need to budget $2000 to the Assigned column of your Quarterlies category.
That money might come from your Ready to Assign number (if you have money sitting there), from a Profit category, or you might just start setting aside 25% of each incoming payment to start padding that category. The way money gets in there is up to you, but now you know how much to start earmarking.
How to Pay Your Quarterly Taxes
In the US, the due dates for quarterly payments are in April, June, September, and January (of the following year).
Let’s say it’s September 1st, and we just finished doing the books for August. We had profits of $8,000 so we budgeted $2,000 into the Quarterlies category for September. In fact, we’ve done that for three months now:
So our Quarterlies balance is now $6,000 ($2,500 from June, $1,500 from July, and $2,000 from August). Now we simply cut a check, or use EFTPS.gov if you’re in the US, to pay the $6,000 to the tax man. Because you’re following Rule Two, it doesn’t sting quite as much as the big payment all at once would. That’s what Rule Two is for—and applying it to your taxes will make your life MUCH less stressful.
Why Not Just Do This Quarterly?
Because you’ll forget that the money is spoken for, and you’ll have budgeted and spent it on something else. You need to make sure you budget for your taxes on a regular basis. Don’t kid yourself and think that the money will just magically be there. Too many business owners do just that, and then when the tax bill actually comes due, they’re stressed, scrambling, and scared.
You’ve got a business to run! Implementing a monthly system to accurately estimate and save for quarterly taxes helps streamline your finances so that you can focus on future success instead of fearing the IRS.
Ready to calculate quarterly taxes in a budget of your own? Try YNAB for free for 34 days—no credit card required!
(For tax advice that’s specific to your situation, please consult your trusted tax advisor. This post is intended to help you organize your tax planning to-do list.)