Self-employed people must make quarterly estimated tax payments, as taxes are not automatically withheld from their earnings like they are for employees. Since self-employed income can fluctuate significantly from month-to-month, it can be challenging to determine the precise amount to pay each quarter.Paying too much can strain your finances while paying too little could lead to substantial tax bills and underpayment penalties at the end of the year.
The seven tips below will help you accurately calculate your quarterly tax payments, to ensure that you meet your tax obligations without overextending your budget or facing penalties.
Key Takeaways
- Self-employed individuals must file estimated tax payments at the end of each quarter.
- Ensuring you report your taxes correctly will help prevent overpaying, underpaying and receiving a large tax bill, or incurring costly penalties.
- Opening separate checking and credit card accounts for your business simplifies tracking your earnings and expenses, makes it easier to organize financial information for tax filings, and ensures quick access to necessary details when preparing your tax statements.
- File your quarterly tax payments on time and consider slightly overpaying. Any excess paid can be refunded, providing a buffer against potential underpayment penalties.
- In the first year, get advice from a self-employed friend, a tax advisor, or the IRS helpline.
1. Base Your Payments on Last Year's Earnings
To avoid penalties, you must pay at least as much in taxes as you did the previous year if you were self-employed then too. You can find the total taxes you paid on last year's tax return. Simply divide last year’s total tax payment by four and make these equal payments on the IRS’s quarterly deadlines: April 15, June 15, September 15, and January 15 of the following year.
If you are a resident of a jurisdiction that has suffered a natural disaster, your tax filing dates may have been extended by the government. You can consultIRS disaster relief announcementsto determine your eligibility.
If you match last year's tax payments this year and your taxes are higher, you'll only need to pay the difference at tax time without incurring a tax underpayment penalty.
For example, if you paid $4,000 in taxes last year and make four quarterly payments of $1,000 this year, but find your total tax for the year is $5,500, you can simply pay the additional $1,500 due at tax time without penalty.
You should note that if you had no tax liability in the prior year, you won't face a penalty for not making estimated payments this year. However, you can make payments during the year to avoid a large tax bill later, though it's not mandatory.
2. Get Advice the First Year
During the first year of self-employment, consider consulting with a seasoned self-employed professional or with an experienced tax advisor. Business owners are often too busy to handle accounting and long-term tax planning effectively during their initial startup period. A professional's guidance can help you accurately determine your quarterly tax payments, identify deductible expenses, and familiarize yourself with the tax filing process.
3. Use Separate Accounts for Business Expenses
Opening separate bank and credit card accounts for business expenses can simplify your financial management and make it easier to estimate quarterly taxes.
These dedicated accounts create clear records of your business expenses for easy reference at tax time. It's much simpler than wading through a pile of paper receipts when you're doing your taxes, and it's much easier to check back through if a question about expenses comes up.
In addition, separating your accounts can help establish your business's credit history independent of your personal credit. Setting up accounts under your business's name helps to solidify its identity as a separate entity with its own credit history.
4. Keep a Running Tally of Your Income
If you don't regularly monitor your income and adjust your estimated tax payments as necessary, you might face an unexpectedly high tax bill next April. Calculate your income at the end of each quarter to decide if you need to adjust your quarterly payments. Using a dedicated checking account for your business deposits, you can easily keep a running tally by quickly checking your online bank records.
5. Use the IRS 1040-ES Worksheet
If your income fluctuates significantly from year to year, use the IRS Form 1040-ES worksheet to estimate your quarterly tax payments accurately. This worksheet helps you calculate your expected tax liability and incorporates various deductions you might be eligible for.
You should fill out the IRS Form 1040-ES worksheet every quarter, particularly in quarters when there's a notable change in your income. This adjustment is crucial for businesses with fluctuating earnings to ensure the estimated tax payments accurately reflect your finances, helping you avoid unexpectedly large tax bills in April.
6. Always Overestimate, at Least a Little
Tax penalties can be costly if you underestimate your taxes due. Typically, there's a penalty of about 0.5% per month on the unpaid tax amount, calculated from the due date of the quarterly payment until it's paid. Interest also accrues on any underpaid tax from the due date of each payment until it is fully paid.
Interest on unpaid taxes compounds daily, making it crucial to pay on time or as much as you can afford, as even filing for an extension won't halt the accrual of interest. As of April 1, 2024, the interest rate on underpayments by individual taxpayers amounts to 8%, which is nearly triple the rate levied in 2021.
The IRS sets the interest rate for individual taxpayers based on the federal short-term federal funds rate plus three percentage points each quarter. So, if you underpay for the first quarter of a tax year, you could owe a different penalty than you would for underpaying in the third quarter.
If you're unsure of how much to pay each quarter, slightly overestimate your taxes. You won't lose any money in the long term. You'll just get it back as a tax refund.
7. Put the IRS Tax Help Line on Speed Dial
The IRS's free helpline is your best source for answering any question. The number for individual taxpayers is 800-829-1040.
Unless you employ a tax advisor to handle your taxes, you are effectively your own accounting department. If you're not an accountant, you'll likely have questions, especially during your first year of self-employment.
What Is the Self-Employment Tax Penalty?
The self-employment tax penalty for paying your taxes late is .5% of the unpaid amount for each month or the part of the month the tax isn't paid. If you underpay your taxes, the underpayment rate as of April 1, 2024 is 8%.
What Happens If You Don't Report Self-Employment Income?
Failing to report self-employment income is a serious offense and constitutes tax evasion, a crime under federal and state laws. Penalties for this include fees on the unpaid amount, interest charges, and in severe cases, arrest and possible imprisonment.
How Do I Avoid Paying Taxes If I'm Self Employed?
As a self-employed individual, you cannot avoid paying taxes, but you can reduce your tax bill by claiming legitimate business expenses as tax deductions. The IRS allows deductions for a variety of costs including office equipment, phone bills, gasoline for business travel, and continuing education. These deductions help decrease your taxable income.
The Bottom Line
If you are self-employed, it's crucial to accurately calculate and pay your estimated taxes to avoid underpayment penalties. If you follow the tips above for calculating your quarterly estimated tax payments, you can reduce the risk of fines and interest while keeping within your budget. For guidance tailored to your specific tax circ*mstances, always consult with a tax advisor.
