4 Steps to Calculating Estimated Taxes

The tax system in the United States is a pay-as-you-go system. In other words, taxes must be paid as income is received throughout the year. Two of the most common ways to pay taxes are:

• Withholding from a paycheck or other income source
• Pay estimated quarterly payments

For employees who receive W2 income,  tax payments are generally taken care of in the form of paycheck withholding. However, with life changes, side hustle income, large bonus payouts, or equity compensation, adjustments to withholding might be necessary from time to time.

For self-employed professionals or those who receive income as a 1099 independent contractor, estimated taxes payments are a method to pay taxes throughout the year. However, it’s up to the taxpayer to calculate and pay their tax. Therefore, understanding how to calculate these taxes is essential to maximize your money!

In this simplified step-by-step calculation, you’ll learn how to calculate estimated tax payments easily. Remember, you’ll need to adjust the numbers to fit your specific situation, but this will give you the tools necessary to calculate estimated tax payments.

Step #1. Estimate Taxable Income

Meet Josh. Josh is an entrepreneur and owner of a single-member LLC. He is a single tax filer and expects to net about $125,000 in earnings from his business. Remember, net earnings are after all business-related expenses.

While we project his net income to be $125,000, we know this might change, so this serves as a starting point. To project income, use your previous earnings to generate a forward-looking expected income number. If you’re starting and don’t have earnings, make your best estimate and start there.

In addition to income, Josh makes an annual $6,000 traditional IRA contribution. IRA contributions are considered an above-the-line deduction (tax lingo) and reduce his adjusted gross income.

Further reducing his taxable income is 1/2 of the self-employment tax, a deduction for self-employed folks. We calculate the self-employment tax in the next step, which will make more sense.

We now have Joshes estimated adjusted gross income for the year. The last thing we need to do is subtract the standard deduction (or itemized deduction estimate). Since Josh is a single tax filer for 2022, he gets to use the standard deduction of $12,950.

Josh’s taxable income projection for 2022 is $97,219.

Step #2. Calculate Self-Employment Tax

Self-employment taxes catch many entrepreneurs off guard. This tax consists of social security and medicare tax. The difference between being an employee and being self-employed is that as an employee, you split social security and medicare tax with your employer. When you’re self-employed, you pay both parts because you’re considered the employee and employer.

To calculate self-employment tax, we take Josh’s estimated net income of $125,000 and multiply it by 92.35%. Only 92.35% of net income is subject to self-employment tax to adjust for being self-employed. So only $115,438 is subject to self-employment tax.

Multiply this self-employment taxable income by the self-employment tax rate of 15.3%, and we get a tax of $17,662 (half of this is the deduction referred to in step 1 to calculate estimated taxable income).

A note on self-employment tax:

• Social security tax is 12.4% + 2.9% for medicare = 15.3%.
• The wage base for 2022 is $147,000 per person. Social security is paid on earnings up to this amount.
• The medicare tax of 2.9% applies to earnings up to $200,000 (individual/head of household), $250,000 (married), or $125,000 (married filing separately) and then increases by 0.90% for a total of 3.8% without limit.

Step #3. Calculate Income Tax

As we calculated in step 1, Josh’s taxable income is $97,219. This amount gets pushed through the tax brackets to determine the federal tax liability. If you don’t have tax software or a professional, you can estimate this on your own by referencing a tax bracket and rate breakdown.

Josh has income in the 10%, 12%, 22%, and 24% federal tax brackets, which break down like this:

Josh is in the 24% marginal tax bracket, but his income goes through each bracket to determine the tax liability. His estimated income tax is $15,213 (tax due through the 22% bracket) + $1,955 (tax due for income in the 24% bracket).

Josh’s estimated income tax is $17,167.

Step 4. Calculate Total Tax and Estimates

We now have everything calculated to the best of our estimates. Josh is expected to have a self-employment tax of $17,662 (from step 2) and a federal income tax of $17,167 (from step 3). Both taxes are part of the estimated tax calculation of $34,829. Divide this by four to get the quarterly tax estimates of $8,707!

As Josh’s income is on target with our projection, he can make these estimated payments by the quarterly due dates to avoid under/overpaying tax or paying penalties. Remember, these are estimated taxes, not “exact” taxes. If Josh’s income is much higher or lower than expected, we will re-calculate the projection and adjust estimated taxes.

To recap, here is a breakdown of the steps to calculate estimated quarterly tax payments:

Important Considerations

• To keep things simple, we did not factor in the Qualified Business Income Deduction (QBI). This deduction applies to many entrepreneurs but does have limitations for higher earners. Again, your financial or tax professional should include this in your estimates.
• For LLCs taxed as an S corp, the estimated tax calculation will be different. The salary from an S corp is subject to self-employment and income tax, generally done through payroll withholding. The profit distributions are not subject to self-employment tax, but quarterly tax payments might be necessary for federal/state taxes.
• If you have income as a w2 employee or a spouse with w2 income, be sure to include their tax withholding and income when calculating total tax.
• The final estimated tax payment for the previous year is due Jan 15. The payment deadline after the end of the year gives added flexibility to true up the final tax payment based on the tax paid and income received for the year.
• The calculation we covered is only for federal income taxes. If you live in a state with state taxes, include state tax with your estimates. Then, check with your state on how to make payments.

Estimated Tax Due Dates:

We can’t discuss estimated tax payments without letting you know when they are due! So here are the due dates for federal tax payments:

Estimated tax payments don’t have to be confusing. However, even though they are estimates, the more accurately you can project income and calculate estimated tax payments, the less likely you’ll have an unwanted tax bill or penalty.

Being an entrepreneur means wearing many hats. So let’s start with a chat if you aren’t confident in your financial and tax plan or need someone to collaborate with.