Being self-employed these days is more common than ever before. More people are deciding that it’s better to be their own boss rather than punch a time clock. In addition, the gig economy, as it’s called, means that more people are opting to “piecemeal” their income, getting work here and there instead of working for an employer. However, being self-employed brings its own unique set of challenges and freedoms. Chief among these challenges is the responsibility of handling your own taxes, including making quarterly tax payments. Unlike traditional employees, self-employed individuals must estimate and pay taxes on their income throughout the year. Of course, this isn’t a literal need to handle your own taxes. Most savvy self-employed people hire a CPA to handle taxes, since they are often even more complicated than if the person worked for a separate company. Still, there is some planning to do when it comes to quarterly taxes, so that the outgoing money doesn’t take you off-guard.
What Are Quarterly Taxes?
Quarterly taxes, also known as estimated taxes, are payments made four times a year to cover income tax, self-employment tax and other related taxes. The IRS requires self-employed individuals to make these payments if they expect to owe $1,000 or more in taxes when their annual return is filed. Your CPA can advise you as to whether or not you’re required to pay quarterly taxes.
The Impact on Cash Flow
Coming up with the money to pay quarterly tax payments can be challenging for the self-employed. One main reason is that cash flow is a common challenge for people working for themselves. It certainly takes some experience and finesse to ensure positive cash flow each month, even in a traditional business environment. For this reason, it’s helpful to learn how to calculate your estimated tax payments ahead of time. Your CPA can help you with this task, but you should learn how to do it, as well.
Calculating Your Estimated Tax Payments
1. Estimate Your Annual Income
Start by estimating your total income for the year. This includes income from all sources, such as freelance work, gig economy jobs, and business profits.
2. Calculate Your Adjusted Gross Income (AGI)
Your AGI is your total income minus any adjustments, such as retirement contributions and health insurance premiums.
3. Determine Your Taxable Income
Subtract your standard deduction or itemized deductions from your AGI to get your taxable income.
4. Apply the Appropriate Tax Rates
Use the current year’s tax rate schedules to estimate your tax liability. Don’t forget to include self-employment tax, which covers Social Security and Medicare taxes.
Understanding Self-Employment Tax
Self-employment tax is a significant part of your estimated taxes. It comprises Social Security and Medicare taxes and is calculated at a rate of 15.3% of your net earnings from self-employment. This includes both the employer and employee portions of these taxes.
Making Your Quarterly Payments
Once you’ve calculated your estimated taxes, it’s time to make your payments. The IRS has set specific due dates for these payments:
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April 15 for income earned from January 1 to March 31
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June 15 for income earned from April 1 to May 31
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September 15 for income earned from June 1 to August 31
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January 15 of the following year for income earned from September 1 to December 31
You can make your payments online through the IRS Direct Pay system, by mail using Form 1040-ES, or via the Electronic Federal Tax Payment System (EFTPS).
Protect Yourself by Setting Aside Money for Taxes
To ensure that you always have the cash available to pay your quarterly taxes, experts recommend that you set aside the money. Don’t even factor it into your income. One of the biggest challenges for self-employed individuals is setting aside enough money to cover their quarterly tax payments. Here are some tips to help you get it done:
1. Create a Separate Tax Account
Open a separate bank account dedicated to your tax savings. Transfer a portion of your income to this account regularly. It could be as simple as a second savings account, connected to your business checking account. Keep it at the same bank so you can transfer money into it in seconds.
2. Use a Percentage Method
Calculate a percentage of your income to set aside for taxes. A common recommendation is to save 25-30% of your earnings. Get together with your CPA to figure out what percentage you should use. If it consistently ends up being too much or too little, you can always tweak it.
3. Automate Your Savings
Consider setting up automatic transfers to your tax savings account to ensure you consistently save money for your quarterly payments. Depending upon your banking institution, you could automatically have a certain amount transferred each time you make a deposit.
Benefits of Paying Quarterly Taxes
By now, you may feel like paying quarterly taxes is a burden. But there are some advantages that come with the territory, including:
Avoidance of Penalties
Paying quarterly taxes if you fall into the correct category isn’t an option; it’s obligatory. By paying them as directed you can avoid hefty IRS penalties.
Better Management of Cash Flow
When you know you have to pay quarterly taxes, you may have a tendency to pay closer attention to your cash flow, which is always a good thing.
Peace of Mind
It feels good to know that you’re in compliance with the law. This may reduce stress and allow you to focus on growing your business.
Planning for quarterly taxes as a self-employed individual requires diligence and careful calculation. By estimating your income accurately, setting aside money regularly, keeping detailed records, and staying informed about tax laws, you can ensure that you meet your tax obligations and avoid unnecessary penalties. Remember, consulting a CPA can provide additional peace of mind and help you navigate the complexities of self-employment taxes.
by Kate Supino