Managing Your Tax Payments When Your Monthly Income Varies
By Trent Derrick, CMT®
For most individuals, taxes are a once-a-year concern. With taxes automatically deducted from their paychecks, they only need to focus on filing their returns come April. However, as an entrepreneur or small business owner, your income is often uncapped—and that comes with a more complex tax situation.
Effective tax planning is essential for strategizing your variable income and potentially reducing your tax burden. Here are five actionable steps you can implement to manage your tax liabilities as a business owner.
1. Understand When Estimated Tax Payments Are Due
Self-employed individuals and entrepreneurs are responsible for paying taxes directly to the IRS in the form of quarterly estimated payments. Being your own boss means you have to calculate and remit payment for what you owe; it’s not automatically deducted from your paycheck like it is for W-2 employees.
This is great in that you don’t have to pay taxes right away, but it can quickly become an administrative and financial burden if you don’t stay on top of it.
To better manage your tax payments, you must first understand when they are due. This table highlights the typical due dates for quarterly estimated tax payments: (1)
Failure to pay your estimated taxes or late payment may result in hefty penalties and fees charged by the IRS, so it’s critical to stay on top of these dates.
2. Understand How Much You Should Pay
Understanding how much you should pay in taxes can be especially difficult if your income fluctuates each year. If you overpay, you run the risk of giving the IRS an interest-free loan, and if you underpay, you run the risk of being penalized. In this case, the safest thing to do is to avoid the underpayment penalty by paying the lesser of the following: (2)
- 90% of your current year tax liability or
- 100% of your prior year tax liability (if your adjusted gross income for the prior year was more than $150,000, then you must pay 110% of your prior tax liability)
Keep in mind that the IRS also provides a stipulation if you receive uneven income throughout the year. You may be able to reduce or avoid penalties by annualizing your income and making unequal payments throughout the year. (3)
3. Create a Tax Plan
After you determine how much tax you should pay, the next step is to create a tax plan to ensure you save the appropriate amount. The general rule of thumb is for self-employed individuals to set aside 25-30% (4) of their income for taxes, but the exact amount you need to set aside depends on your business structure, tax bracket, state of residency, and more.
For individuals with irregular income, it’s important to adjust your savings as your income fluctuates. If you have a particularly successful month, consider putting 50-60% away to make up for months where your income is lower. Working with a wealth manager or utilizing a bookkeeping system are great ways to stay on top of your tax payments so you don’t find yourself facing a penalty come tax season.
4. Keep Track of Deductions
It’s easy to forget about all the expenses you paid for when you’re focused on managing your irregular income. But it’s important to document as much as you can in order to take advantage of every deduction. This may help you reduce your tax liability, ultimately reducing your estimated tax payments and putting less strain on your uneven cash flow.
There are dozens of expenses you can deduct (5) as an entrepreneur or real estate broker. Here are a few of the most common deductions:
- Startup costs
- Advertising
- Online services and subscriptions
- Travel expenses
- Continuing education
- Software, hardware, and other equipment
- Health insurance premiums and medical care expenses
- Home office and supplies
- Retirement contributions
5. Collaborate With an Experienced Advisor
Handling tax payments can feel overwhelming, but with the right guidance, it doesn’t have to be complicated. At Legacy Wealth Management, we help entrepreneurs and small business owners navigate the challenges of a variable income.
Do you feel uncertain about your tax planning or need assistance making sense of it all? We’re here to provide clarity and confidence to your financial process. Reach out to me at trent@legacywm.com, and let us help you take control of your finances.
About Trent
Trent Derrick is a financial advisor and Chief Market Technician at Legacy Wealth Management. He is passionate about the value small businesses bring to their communities and specializes in serving small business owners by providing seamless financial advisory services tailored to their financial needs, including tax planning strategies, cash flow management, and retirement planning. Trent obtained his bachelor’s degree from the College of Charleston, studied economics at the University of South Carolina, Columbia, and is a Chartered Market Technician® (CMT®) professional. Outside of the office, he serves as a guest lecturer for the College of Charleston’s MBA program and acts as chairman of the Market Technician Association’s Charleston chapter. To learn more about Trent, connect with him on LinkedIn.
The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
Legacy Wealth Management and LPL Financial do not offer tax advice or services.
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(1) https://www.irs.gov/faqs/estimated-tax/individuals/individuals-2
(2) https://www.hrblock.com/tax-center/irs/tax-responsibilities/avoiding-underpayment-tax-penalty/
(3) https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes
(5) https://money.usnews.com/money/personal-finance/taxes/articles/self-employment-tax-deductions