Federal income tax is a pay-as-you-go system. S corporation income generally passes through to the shareholders, who report their share of the business income on their personal tax returns. A shareholder may owe tax on this income even when the business does not distribute all of the cash.

Individuals, including S corporation shareholders, generally need to make estimated tax payments when they expect to owe at least $1,000 after subtracting withholding and available tax credits. Payments are normally made four times during the year. A penalty may apply when the required amount is not paid by each applicable due date.

Many taxpayers can avoid an underpayment penalty by paying at least the smaller of:

  • Ninety percent of the current year tax
  • One hundred percent of the prior year tax

For certain higher income taxpayers, the prior year percentage increases to 110 percent. The prior year return must cover a full twelve-month tax year. This rule may help avoid an underpayment penalty, but it does not guarantee that there will be no balance due when the return is filed.

Estimated payments should be reviewed when income changes significantly, a large transaction occurs, or the business becomes substantially more profitable. Some S corporation owners may also increase federal withholding through payroll rather than making separate estimated payments.