 Income tax 2023-2024, small business, how to pay income tax. Get ready and some coffee because to be a great tax preparer, you need to be like a scarecrow, outstanding in your field. Most of this information can be found in publication 334, tax guide for small business for individuals who use Schedule C tax year 2023, which you can find on the IRS website at irs.gov, irs.gov. Looking at the individual income tax formula. Remember in the first half of the income tax formula is in essence a funny income statement. Most income statements having income minus expenses resulting in net income. Here having income minus deductions resulting in taxable income with regard to sole proprietorship. Schedule C's were focused on line one income which can be deceiving because the Schedule C itself is an income statement in essence having income minus business expenses otherwise known as business deductions resulting in net Schedule C business income which is what flows into line one. 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And yes, I know six pack isn't spelled right but three letters is more efficient than four so I trimmed it down a bit. Okay, it's an improvement. If you would like a commercial free experience consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com Income of the income tax formula. This is page one of the form 1040 where the schedule C eventually flows into line number eight. Additional income from schedule one line 10. This is the schedule one additional income and adjustments to income part one where the schedule C eventually rolls into line three business income or loss from the schedule C. And here's the schedule C profit or loss from business which has an income statement format income minus expenses resulting in in essence net income. Okay, how do I pay income taxes? Obviously you grit your teeth, you scream and get angry as you write the check or make the electronic transfer followed by a strong drink. But also federal income tax is a pay as you go tax. You must pay it as you earn or receive income during the year. Now, this is similar. Of course, if we have the W to employee, although once again, as employees, we often don't really think about how the system is processed because it's basically put on the employer to do most of the work to make the withholdings in other words and pay it to the government on our behalf and then do the reporting on the W to both to us and to the IRS. The argument from the IRS's perspective as to why the employer is making those withholdings is to make it easy on us. But obviously that's bull something that's not that because they want their money sooner and they want it to be withheld by the person they have leverage on, which is of course the employer. So the idea there is as we earn the money, the IRS wants the money as we earn it. The same thing is going to happen when we have a Schedule C business. We might say, hey, look, I'm just going to wait until I file my taxes for tax year 2023. That's going to happen by April 15, 2024. And then I'll just pay all my taxes at that point in time. Won't that be okay with the IRS? No, it won't. They're going to hit you with penalties and interest, the sticks that they wheeled at you. If you do that, why? Because they want to get paid as you earn the money. So during the year, next question will be, well, how am I going to do that? I don't know how much money I'm going to earn because it's a new business and I'm going to have to do the bookkeeping and then figure out my income statement before I have any idea how much I actually earned. And even if I did know how much I earned, it's going to be difficult for me to estimate my taxes because I have to basically estimate my yearly earning in order to calculate the taxes. In other words, if you're a W-2 employee, you don't calculate your estimated payments by what you made every week or every other week because we don't have a flat tax system. You can't just say, well, I made $500, so I'm going to pay like 10% of that because your tax rate might be higher or lower possibly than 10%. What we have to do is annualize your taxes and say, well, you're going to make $100,000 in the year so that we can then do a progressive tax system calculation applying multiple tax rates to your estimated income so that we can then have an average tax rate that we're going to apply to your tax during the year. That's actually quite complex and a small business doesn't really know all that, especially if they're new. So they often stumble at that starting point and they often also forget about the fact that they not only have federal income taxes, but the self-employment taxes that they have to budget for and they have to pay and they have to do it as the year goes. Okay, so an employee usually has income tax withheld from their pay if you do not pay your tax through withholding or do not pay enough tax that way you might have to pay estimated taxes. So in other words, you might have a W-2 job in which case the employer is taking money out of your wages based on what you told them on the W-4, but they are basically doing that. Now, you could then have a side job like gig work, for example, and you might have a schedule C as well as W-2 employee work. If that happens, then the withholdings that you figured on the W-2 probably are not sufficient to now cover the added income in the event that you have income on your side job, your side business, and therefore you could increase the withholdings that are taken out of your wages so that it will now cover your other income or possibly you just removed yourself from employment altogether. You're like, I'm sick of having bosses and whatnot. I'm doing my own thing. And then if you do that, then of course you don't have anybody to do the withholdings at all and therefore you're going to be forced to make estimated tax payments. So that's going to be the general. Now, how are you going to do that? You're going to have to do some kind of projection, which means you could use tax software if you have an availability of tax software and you have to do some bookkeeping to try to project how much you're going to earn. And the IRS also has a tax calculator for withholding calculator, which is getting more sophisticated and is closer to basically tax software, which is another great tool that you could use to try to figure out and pay your estimated taxes so you don't get hit with the sticks. That's the point. That's what we're trying to do with taxes. The sticks in metaphorical terms are interest and penalties that we're trying to avoid. So estimated tax payments. You generally have to make estimated tax payments. If you expect to owe taxes, including self-employment tax, Social Security and Medicare, discuss later of $1,000 or more when you file your return. What happens if I don't, you might ask. What if I don't do that? Well, they hit you with the sticks metaphorically, the interest and penalties. We're trying to avoid the sticks. So use Form 1040ES to figure and pay the tax. If you do not have to make estimated tax payments, you can pay any tax due when you file your return. For more information on estimated tax, you can see publication 505. So what are my options for paying estimated taxes? You can pay your estimated tax electronically using various options. Now, you might think, well, that's quite nice of you, IRS. You made it easy for me to pay the taxes, but it actually is quite nice of them. Because before these electronic payment transactions and whatnot, it was actually difficult to pay them, which was kind of a pain because now you're saying the IRS is saying, you have to pay me by this time, but I'm going to make it difficult to pay. And then if you don't pay by that time, they're going to hit you with penalties and interest. So at least they make it easy to pay for the most part. But if you file electronically or pay them electronically, you need to make sure that you're applying it to the proper year. So for 2023, you might be making tax payments in 2024 that should be applied to 2023. What if you apply it to the wrong year? Well, then the IRS is probably still going to hit you with a penalty because it's applied to the wrong year, right? Or in some cases, if you applied it to 2023 instead of 2024, they might refund the money to you and then charge you taxes because you didn't pay for 2024. So we want to be careful and make sure that we have the estimated tax payments properly calculated to the best of our ability and when made, applied to the proper period. So if you pay electronically, there is no need out to mail in form 1040 ES payment vouchers. This is of course what the IRS is trying to do more and more these days to make people pay electronically, which is nice and easy to do because you can verify the transaction. If you want them to lag longer, you can send it to them by mail with the good old 1040 ES might take them longer to process it, you know, and so on, but whatever. So these options include paying electronically through the electronic federal tax payment system, otherwise known as the EFTPS system. You can pay with the direct pay by authorizing and electronic funds withdrawal when you file form 1040 or 1040 SR electronically. In other words, many times when you file the return, you're filing it with tax software these days. And the tax software could possibly have the ability to do electronic transfers through it, which will then basically require generally the routing number and account numbers, you know, for your bank. So you can do electronic transfer possibly that way. Paying by credit or debit card over the phone or by internet. Remembering that if you pay by credit or debit card, I don't believe the IRS charges you fees, but your debit or credit card might. So some kind of electronic transfer is probably, you know, the cheapest option or or a check if you still want to go that route. So other options include crediting and overpayment from your 2022 return to your 2023 return or 2023 estimated tax or mailing a check or money order with form 1040 ES payment voucher. So notice the taxes are usually paid on a quarterly basis. That's when the IRS wants them. If, for example, we're talking about 2023, then we might have had an overpayment of 2022 where we had a business income schedule C. And then instead of having them give us the overpayment in the form of a refund, we said, Hey, just roll it over to 2024, which would be equivalent then to them giving us the money. And then we gave it right back to them. So instead of that, we just said, Don't give me the money. Just make it part of the estimated payments for 2024. And then we might make payments during 2024 payments, which are usually scheduled and calculated based on and using the prior year tax software, which is, which as a system that works generally fairly well and can help us to hit like safe harbor requirements to hopefully avoid or minimize the chance that we get hit with those sticks metaphorically of the penalties and interest. The last payment we have a cutoff situation because the last quarterly payment we might still make for 2023 in 2024. So that's where you have this cutoff situation. You're like, Okay, I paid it on time, but the actual money went out in 2024, even though it was paid for tax year 2023 as a tax payer. As a tax preparer, we have to be careful of those cutoffs. We have to look at the payments that were made in the beginning of the year and say, were these payments tied to 2022 or 2023. If we're using the same software, we can see the last year payment. If there was a refund, if it rolled into as an estimated payment for the current year of 2023. And we want to see if any payments were made after the end of the year in 2024, which were still applied to 2023. We can also often verify the payments that were made or were not made because the tax software is what created the tax payment schedules. And so we can try to say, were the payments actually made in accordance with the plan payments that were made based on the prior year tax software. Now, obviously, if you have a new client or you have a new business that's coming up, then you don't have the prior year to rely on to help you out with the calculating of the estimated tax payments. And you possibly have to do more planning as you have a new or unstable business, one that changes, one that you don't know what the revenue is going to be from year to year month to month day to day. Penalty for underpayment of tax. So here's the metaphorical sticks we're trying to avoid. This is the whole point. We can't avoid the taxes. We're going to pay the taxes that we are legally required to pay, attempting to file the tax returns so that we are paying the minimum that were legally required to pay. So that it is what it is, right? However, we don't want to be tacking on top of that the added penalties, the added beating that we can take from the sticks of penalties and interest, right? So if you did not pay enough income tax and self-employment tax for 2023 by withholding or by making estimated tax payments, you may have to pay a penalty on the amount not paid. Now, I just want to point out that many small businesses that move from a W-2 employee to a sole proprietor, even if they do quite well, again, they forget to do the estimated tax payments because they're not used to it. They haven't been trained. They don't really understand that they're even paying taxes because of the way the W-2 system kind of worked before. So what happens if they don't pay taxes in the current year, they're going to be behind on the taxes and then they're going to have to prepay the taxes for the next year, which means they would have to pay two years of taxes in essence, right? In order to get caught up again. So we really want to not do that because that's highly detrimental to a business to be in the hole because of taxes, because they did well and then didn't pay the taxes because they didn't really understand they had to pay as they go kind of system. So you could really help a lot of small businesses if you can make them aware of their tax obligations and when they need to pay them generally. So the IRS will figure the penalty for you and send you a bill or you can use Form 2210 under payment of estimated tax by individuals, estates, and trusts to see if you have to pay a penalty and to figure the penalty amount. So oftentimes tax software will help you to kind of calculate if the payments were not made properly over the time frame. But sometimes it's not exact because the IRS then might give you a notice saying that you have late payments and they're charging you basically penalties and interest in that format. So for more information you can see Publication 505.