This Rookie Mistake Cost Me Hundreds When I Started My Business

I was a day (or 30) late and a dollar (ish) short.

Going out on your own and starting a small business is exciting. And, in many states, it's remarkably easy, especially when you're a sole proprietor operating under your own name. You may not even need to file paperwork, depending on your situation.

However, there's one thing even the smallest of small businesses typically need to do -- or else. And that's paying quarterly estimated taxes.

Unfortunately for me, the "estimated" part of the equation is a bit more complicated than I anticipated. And underestimating my taxes led to a very unpleasant penalty when it came time to file my taxes in the spring.

Estimate your profits -- but don't aim too low

There are a few ways you can avoid the underpayment penalty. The most obvious is to simply ensure you pay enough in taxes. This means paying the lessor of:

• 100% of last year's tax, or
• 90% of this year's tax

(If your adjusted gross income for last year was $150,000 or more, your percentage increases to the lesser of 110% of the previous year or 90% of this year.)

Alternatively, you may also avoid the penalty if you fit into one of these cases:

• Having no tax liability the previous year (you must be a U.S. citizen, and the prior tax year must cover a 12-month period)
• Experiencing an extenuating event, such as a natural disaster or major casualty
• Becoming disabled during the previous or current tax year
• Retiring during the previous or current tax year (at age 62 or older) while demonstrating a reasonable cause for not making your payment

For me, the problem was two-fold. The main issue was that it was my first year working on my own, which meant I didn't have any previous years to compare to when it came to estimating how much money I would make. And since the previous year hadn't been a full tax year (for various reasons), I couldn't even fall back on that exception.

In the end, my only real option for avoiding the penalty was to ensure I paid 90% of the current year's taxes. But without knowing how much money I would be making over the course of the year, that became a very complicated guessing game.

And I lost.

On the one hand, that was a good thing. It meant that I wound up making more money than I had expected to make. On the other hand, it also meant that I owed more money to Uncle Sam -- and he charged me extra fees for not handing it over sooner.

In the scheme of things, the fees were relatively minor. But the extra tax bill plus the penalties definitely added up. It was a valuable lesson (albeit one I'd have happily done without).

When in doubt, hire a professional

If you think you qualify for an exception to the penalty but aren't sure how to go about obtaining it, consult a tax professional. In fact, that's a smart move to do when you start a business anyway. They can help you determine how to properly estimate your taxes, when to pay them, and any other pitfalls to avoid.

Or there's always the software route. There are tons of popular small business tax software solutions out there. The small monthly fee I pay for mine is well worth it for the peace of mind in knowing what and when to pay to avoid getting on Uncle Sam's bad side (again).