Quarterly estimated taxes for private practice owners

Most private practice owners pay federal income tax two ways at once: through withholding, if they draw a salary from their own S corporation or a spouse has a paycheck, and through quarterly estimated payments on income that nothing withholds from. An owner who skips those estimates, or makes them late, owes an underpayment penalty under section 6654 even if the whole balance is paid in April.

The rules are more forgiving than their reputation, and they reward planning more than precision.

What the penalty actually measures

The underpayment penalty works like interest. For each installment period it looks at how much should have been paid by that due date, how much actually was, and how long the shortfall lasted. That is why a large payment in December does not fully cure a shortfall from April: the penalty on the earlier periods has already run. It is also why the penalty is often smaller than people fear. It is a rate applied to a shortfall for a period of time, not a percentage of the year’s tax.

The four federal due dates for individuals are April 15, June 15, and September 15 of the tax year and January 15 of the following year, moving to the next business day when one falls on a weekend or holiday. The periods are not equal quarters. The second installment covers two months of income and the fourth covers four.

The safe harbors

You avoid the penalty if your withholding and timely estimated payments, paid in the required installments, reach the lesser of 90 percent of this year’s tax or 100 percent of last year’s tax. When last year’s adjusted gross income was above $150,000, or $75,000 for married filing separately, the prior-year figure becomes 110 percent. There is also no penalty when the balance due after withholding and credits is under $1,000.

For a practice owner the prior-year safe harbor is usually the one that matters, because it is the only one you can compute in January. This year’s income is a forecast until December, while last year’s tax is a number on a filed return. Pay a quarter of the prior-year figure, at the percentage that applies, on each due date and there is no underpayment penalty even if the practice has a much stronger year.

That is also where growing practices get caught. A group practice that adds three associates can meet the safe harbor exactly and still owe a large balance at filing, because the safe harbor protects against the penalty and not against the tax. Setting the difference aside during the year is a cash question rather than a compliance one, and it is worth planning for on purpose.

S corporation owners have an extra tool

Withholding is treated differently from estimated payments. Under section 6654(g), income tax withheld from wages is treated as paid in equal parts on each installment date, regardless of when during the year it was actually withheld, unless you choose to show the actual dates it was withheld. Estimated payments count only when they are made.

An owner who draws a salary from their own S corporation controls their own withholding. If the year turns out better than expected, raising federal withholding on the owner’s last payrolls of the year can close a shortfall and have it treated as paid evenly across all four periods, which an extra estimated payment in December cannot do. It has to run through actual payroll, deposited and reported on the corporation’s Forms 941 and the W-2, so it is only as useful as the payroll is reliable. Setting the salary itself is a separate question, covered in our post on salary for clinician-owners.

Income that arrives unevenly

Practices do not earn evenly. Insurance reimbursements lag the sessions they pay for, a practice that opens mid-year has nothing to estimate against in the spring, and testing, forensic, or contract work can arrive in lumps. When most of the year’s income arrives late, the annualized income installment method lets each installment be computed from income actually earned through that period instead of assuming a quarter of the year each time. It is reported on Schedule AI of Form 2210, it needs period-by-period records, and for a practice whose income is weighted toward the end of the year it is often the difference between a penalty and none.

What goes into the estimate

For a sole proprietor or a partner, the estimate covers both income tax and self-employment tax on the practice’s profit, since nothing withholds either. For an S corporation owner, Social Security and Medicare on the salary run through payroll, and the estimates cover the income tax on the pass-through profit that salary withholding does not already cover.

The common mistake in both cases is estimating against the practice alone. Investment income, a spouse’s income, and the phaseout of the qualified business income deduction for a health practice all change the household’s tax, and the estimate is a household number.

States are separate

Most states with an income tax run their own estimated payment system, with their own due dates, safe harbors, and penalties, and they do not always mirror the federal rules. An owner whose practice has clients or staff in more than one state may owe estimates in more than one, which is covered on our multi-state taxation page and in our post on remote work. Some states also let the practice entity pay tax at the entity level, which changes what the owner needs to estimate personally. Whether to do that is a decision to confirm each year rather than a default to carry forward.

A workable routine

Set the four payments in January from last year’s return, using the safe harbor that applies. Look at the practice’s year-to-date profit after the second installment and again in the fall, and decide whether to set aside more cash for April or, for an S corporation owner, adjust withholding. Keep the confirmation for every payment. That routine is most of what tax planning means for a practice owner, and it is part of the ongoing work in every private practice engagement.

• Estimated tax
• Private practice
• Tax planning