Holy Crap! I’m Self-Employed! - What’s a Quarterly!?!?

This series is aimed at helping self-employed individuals navigate commonly encountered complex accounting issues. Issues regarding corporations or other fictitious entities fall outside the scope of this article and this series.

While the IRS and the FTB have their own instructions on each of these topics, some of which are referenced herein, it has been communicated by multitudes of clients that such instructions are woefully unclear, convoluted, and extremely difficult to navigate. This series is intended to address this issue.

As an unfortunate byproduct of the world we live in, taxes are an almost inexorable source of anxiety for all businesses, and tax authorities like to be paid as soon as possible. They especially do not want to wait an entire year to collect their dues. 

Instead, the Internal Revenue Service (IRS) and the Franchise Tax Board (California’s tax authority, a.k.a. the FTB) require regular payments to be made ahead of time throughout the year. For those employed by a company, this is accomplished through withholding of salaries and wages. No such provision exists for the self-employed, and therefore they must make estimated payments on a quarterly basis if they expect to owe taxes in excess of a certain threshold. For the IRS, that threshold is $1,000. For the FTB, the threshold is $500.

These payments are known as “estimated tax payments,” or more commonly, “quarterlies.”

The IRS’ instructions on making these payments can be found here (https://www.irs.gov/pub/irs-pdf/f1040es.pdf).

The FTB’s instructions can be found here (https://www.ftb.ca.gov/forms/2018/18-540ES-instructions.shtml).

26 U.S. Code Section 6654 imposes a penalty on individuals who fail to make estimated tax payments. Corporations are outside the scope of this article.

For the IRS, these payments are due in 4 installments (for entities other than corporations), each of which comes due according to the following schedule (assuming a calendar year) 26 US Sec. 6654 (c)(2).

The 1^st installment is due April 15^th of the current tax year.

The 2^nd installment is due on June 15^th.

The 3^rd installment is due on September 15^th.

The 4^th installment is due on January 15^th of the following taxable year.

California requirements differ slightly from federal requirements in that the law specifies not only a due date, but a specific amount associated with that due date. Under typical circumstances, if income is earned evenly throughout the year, the due dates are as follows:

The 1^st installment of 30% of California tax liability is due April 15^th of the current tax year.

The 2^nd installment of 40% of California tax liability is due is due on June 15^th.

No payment is required for the 3^rd installment. 

The 4^th installment of 30% of California tax liability is due on January 15^th of the following taxable year.

If income is earned unevenly throughout the year, the amounts due with each due date change based on the timing of receipt of said earnings. For more information on California estimated payments, especially if income is unevenly earned throughout the year, refer to the rules outlined here. 

To avoid penalties, the quarterly estimated installments need to equal the smaller of two amounts:

Either 90% of the tax shown on the current year’s tax return (or if none filed, 90% of the tax payable for said year);

or alternatively, they need to equal 100% of the prior year’s tax liability.

The exception to this is if the tax payer’s adjusted gross income (covered in another article) exceeds $150,000 for that tax year, in which case they must make payments equal to 90% of the current year’s liability, or 110% of the prior year’s liability; whichever is smaller.

California, in general, has similar requirements to the IRS. More information regarding this can be found here.

If a quarterly estimated payment is due, but one misses making it, such a payment cannot simply be “made up” on the subsequent payment’s due date without penalty. Each payment is its own independent liability on part of the taxpayer.

These rules beg the question, “How do I know what my tax liability is before the year is even over?”

Read this article for instructions on how to calculate one’s tax liability.

Sources:
26 U.S. Code Section 6654
Internal Revenue Bulletin: 2018-10
https://www.irs.gov/pub/irs-pdf/f1040es.pdf
https://www.ftb.ca.gov/individuals/faq/ivr/208.shtml
https://www.ftb.ca.gov/forms/2018/18-540ES-instructions.shtml
RTC Div. 2 Part 10.2 Ch. 4 Paragraph 19025
RTC Div. 2 Part 10 Ch. 2 Paragraph 17041

Disclaimer: None of the above is intended as specific tax advice and should not be construed as such. Any actions taken based on the above information is taken at your own risk.

Please contact the author directly for any inquiries regarding one's own specific situation.