Help, I Didn't Pay Enough Quarterly! Tax Bill Rescues for the Self-Employed

SUMMARY: Sole proprietors face financial challenges, but when those include underpaying quarterly taxes they're asking for trouble with IRS. If you've paid too little, or missed quarterly payments, here's how to bring your tax bill back under control.

There's no question about the rules for some 18 million Americans who've made something good for themselves in the world of self employment. Professionals who earn a decent living at what they do, working for themselves, face quarterly taxes.

If you expect to owe more than $1,000 to the IRS after figuring income-tax withholdings and credits then you're in the quarterly category of payers. In a sense, congratulations: you've built up your business so that even the taxman takes notice.

But here's a not so wonderful truth about the financial lives of the self-employed: they can slip into underpaying taxes, quarter to quarter, and they can even miss quarterly payments altogether. Bottom line, when the rent is due, and that $2,500 you intended to give to Uncle Sam makes up the shortfall for the landlord, rent gets paid first. Decisions such as these can build up, however, especially in the early years of hardscrabble self-employment.

"It does frequently happen that people don't have enough money at the end of the quarter to make their estimated tax payment, particularly when they're just starting out," said Jan Zobel, a tax preparer and consultant, in an e-mail interview. "It seems as if all they can do is keep up with whatever bills they have and there's nothing left over to pay the IRS and/or the state."

Statistics that quantify the problem are hard to come by. Neither Zobel, nor a number of other tax experts that were asked, could say what percent of self-employed taxpayers do get into hot water on a quarterly basis. Even outright tax evasion willfully skipping out on the bill as opposed to falling behind on estimated installments because of financial hardship or record-keeping is a difficult number to pin down.

Our subjects, the self-employed we're considering, presumably fall within a segment of honest, but problem-ridden, payers. They mean to pay their bill to federal and state coffers, but they underpay. And when they do, it means trouble. Let's look at what can be done.

Tackling Your Quarterly-Tax Backlog

Perhaps it happens because of cash flow not covering costs of living, or maybe you've realized that not every sole proprietor including you is as good an accountant as they are, say, a graphic designer. Whatever the reason, if you're in a quarterly-tax fix, let's look at some strategies for coping with your looming bill, and some steps that can help get your tax scenario back under control.

The focus will be on the IRS side of the equation, but these strategies can transfer to state bills as well (though details of penalties and interest will vary).

• File on time, every time. It's in your best interest to file your tax forms by April 15 to avoid failure-to-file penalties. They represent an expensive error: the IRS assesses penalties against the amount you owe 5% for every month past due, up to 25%. If you can make a partial payment, do it. Paying down any amount of the balance only helps you in the long run, and since IRS tax bills can take weeks to arrive after you file, if you have the ability to come up with the balance owed, then you can cut a check when the amount due does appear. Know that you'll be assessed late-payment penalties on the estimated quarterly taxes you did not submit. This is 0.5% for every month the balance is due, up to 25%. In certain cases, you can seek a waiver of these penalties: casualty, disaster, or other unusual events are typically the justification involved. Finally, there's also interest to pay on your balance, which the IRS calculates every three months according to federal short-term rate plus 3%.
• Buy time for paperwork with an extension. Should your situation be one in which you also need more time to prepare your paperwork that is, you haven't pulled together records of expenses and the like file Form 4868 with the IRS by April 15 and you'll automatically receive a six-month extension. But you still owe the balance, starting on that date in April. Meaning, whatever amount of your quarterly taxes you didn't pay is assessed the late-payment penalty, plus interest. So, this is not a way to put off your bill until October 15, it's just a method of avoiding failure-to-file consequences if your record-keeping is in disarray.
• Consider an installment plan. Getting your paperwork in on time opens the door to asking the IRS for an installment plan. You'll still incur interest and penalties in this case, the late-payment penalty drops to 0.25% but you'll be on the path to getting free and clear of what you owe. Installment plans can take some time to get started; the IRS doesn't tend to process its paperwork quickly. But once you have your monthly amount due set on auto-pay, last year's mistake(s) will shrink until you can finish the balance off with a lump final disbursal.

Finally, if your bill is extraordinary, and/or your circumstances won't allow you to pay what you owe under the methods we've just considered you can seek to make an offer in compromise. This means a negotiated amount paid to the IRS as either a lump sum in cash or by installments. It can be a thorny process, and you'll likely want a tax expert's help along the way.

Moving Forward: Better Strategies for Your Tax Future

In all of this, there could be an argument that the self-employed need time to build a business under a lesser tax burden than quarterly filings can pose at the start, and that the IRS ought to bill them differently to foster the kind of enterprise sole proprietors can bring to the nation's table.

Until such a discussion arises, however, know this: if you're having trouble keeping up with quarterly estimated taxes, you're not alone but you can build a better go-forward strategy to stay out of trouble.

Once you've got your tax bill back under control, it's time to recognize one likely root of the problem which is almost always that sole proprietors mix the money needed to pay taxes with money used to operate the business and pay costs of living. A smart way to keep current with quarterly taxes is to avoid this by opening a separate bank account one from which you can't easily transfer funds to your primary or business monies. Sock away some 30% every quarter and make your payments on time from that account. Do it, and you'll never need the preceding advice again.