Why Do Estimated Taxes Trip Up So Many Business Owners?

Because the system is designed around predictable income, and most business owners do not have predictable income. Employees have taxes withheld automatically from every paycheck. Business owners receive income irregularly, in varying amounts, and are responsible for calculating and paying their own taxes four times a year.

1. Using last year's numbers for this year's payments

The safe harbor rules allow you to base estimated payments on last year's tax liability and avoid underpayment penalties. But safe harbor is not the same as accurate. If your income grew significantly, safe harbor payments may leave you with a large balance due in April — even if you avoided the penalty.

2. Not adjusting when income changes mid-year

Business income is not linear. Many business owners set their estimated payments in January and never revisit them, even when their income changes significantly. Quarterly payments should be recalculated quarterly.

3. Forgetting self-employment tax

Self-employment tax — the Social Security and Medicare taxes that employees split with their employer — falls entirely on the self-employed business owner. Many first-year business owners calculate their estimated payments based on income tax rates alone and are surprised by the additional self-employment tax liability at filing.

4. Not separating tax money from operating cash

If tax money is sitting in the same account as operating funds, it tends to get spent. The solution is simple: move a percentage of every payment received into a separate account designated for taxes.