One of the great things about being self-employed is that no taxes are withheld from your pay by your clients or customers. But, this doesn’t mean you can wait until April 15 to pay all the tax you owe for the year.
If you’re self-employed, you ordinarily have to make tax payments to the IRS four times during the year. That is, once every quarter.
The IRS calls these quarterly tax payments estimated taxes. Here’s what you need to know about estimated taxes.
Who has to pay estimated taxes?
You must pay estimated taxes if you expect to owe at least $1,000 in federal tax for the year. This collective group includes income tax, Social Security tax and Medicare tax.
However, if you paid no taxes last year, you don’t have to pay any estimated tax this year, no matter how much tax you end up owing for the year. But this is true only if:
- You were a U.S. citizen or resident for the year, and
- Your tax return for the previous year covered the whole 12 months.
Many self-employed people also work as employees, whether full-time or part-time. They have taxes withheld from their pay by their employers. If you work as an employee, you don’t have to pay estimated tax if the taxes withheld by your employer amount to at least 90% of the total tax you owe for the year.
So, you can avoid paying estimated taxes by asking your employer to increase your employee withholding. To do this, file a new Form W-4 with your employer. There is a particular line on Form W-4 for you to enter the additional amount you want your employer to withhold. Use the IRS Tax Withholding Estimator to make sure you have the right amount of tax withheld.
When to pay estimated taxes
You ordinarily pay your estimated taxes in four installments. The first payment for the current year is due on April 15, as shown in this chart:
|Income Received for the Period||Estimated Tax Due Date|
|Jan. 1 through Mar. 31||April 15|
|April 1 through May 31||June 15|
|June 1 through Aug. 31||September 15|
|Sept. 1 through Dec. 31||January 15 of the following year|
Don’t get confused by the fact that the January 15 payment is the fourth estimated tax payment for the previous year, not the first payment for the current year.
You don’t have to start making payments until you begin earning income. For example, if you don’t receive any income by March 31, you can skip the April 15 payment. In this event, you’d ordinarily make three payments for the year, starting on June 15. If you don’t receive any income by May 31, you can skip the June 15 payment as well, and so on.
You can also skip the January 15 payment if you file your tax return and pay all taxes due for the previous year by January 31 of the current year. This incentive is a little reward the IRS gives you for filing your tax return early.
However, it’s rarely advantageous to file early because you’ll have to pay any tax due on January 15 instead of waiting until April 15. In other words, you’ll lose three months of interest on your hard-earned money.
How much estimated tax do you have to pay?
Ideally, the four estimated tax payments you make each year will add up to your tax liability for the year. However, if your income varies substantially from year to year, it can be hard to estimate how much you must pay during the year.
So, it’s easy to end not paying enough estimated tax to cover all you owe. Unfortunately, if you don’t pay enough estimated tax, the IRS will impose an underpayment penalty.
Fortunately, there is a way to avoid having to estimate how much you’ll earn this year. No matter what your income for the current year turns out to be, you won’t have to pay any penalties if the estimated tax you pay is at least the smaller of:
- 90% of your total tax due for the current year, or
- 100% of the tax you paid the previous year or 110% if you’re a high-income taxpayer (those with adjusted gross incomes of more than $150,000 or $75,000 for married couples filing separate returns)
Many self-employed people establish separate bank accounts to save up for taxes into which they deposit a portion of each payment they receive from clients. This step gives them some assurance that they’ll have enough money to pay their taxes.
The amount you should deposit depends on your federal and state income tax brackets and the number of your tax deductions. Depending on your income, you’ll probably need to deposit 15% to 50% of your pay in the highest tax brackets. If you set aside too much, of course, you can always spend the money later on other things.
How to pay estimated tax
The IRS makes it very easy to pay estimated tax. You can pay online, by mailed check, or even by credit card. For details, visit www.irs.gov/payments.
What if you’ve pad too little?
The IRS imposes a money penalty if you underpay your estimated taxes.
You have to pay the taxes due plus a percentage penalty for each day estimated tax payments were unpaid. The percentage is set by the IRS each year. Currently, it’s about 6 percent. This is one of the smallest IRS interest penalties.
Some self-employed people decide to pay the penalty at the end of the tax year rather than take money out of their businesses during the year to pay estimated taxes.
If you do this, though, make sure you pay all the taxes you owe for the year by April 15 of the following year. If you don’t, the IRS will tack on additional interest and penalties. The IRS usually adds a penalty of 1/2 to 1 percent per month to a tax bill not paid when due.
For more details on estimated taxes, refer to IRS Publication 505, Tax Withholding and Estimated Tax.