Did you remember to pay your quarterly taxes? Tax time comes around more than once a year when you're a business owner.
For freelancers, tax time can be hectic. You’ve got to gather all of your documents and prepare your return (or work with a professional who will prepare it for you). Sometimes, you even have to write a big check to the IRS. This is bad enough once a year, but for freelancers, tax time happens four times a year.
The U.S. has a “pay-as-you-go” tax system, so taxes must be paid as you earn or receive income. For employees, those payments are handled by withholding taxes from a paycheck. Freelancers have to manage tax payments themselves though quarterly estimates.
Whether you’re a new freelancer who’s just trying to figure this out or an experienced pro who needs a refresher, this guide will help you decide if you need to pay and provide strategies for making quarterly estimated tax payments.
First, Who Must Pay Quarterly Estimates?
Individuals, including sole proprietors, partners, and S corporation shareholders generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.
If you don’t pay enough tax, you may be charged a penalty. You may also be charged a penalty if your estimated tax payments are late, even if you are due a refund at year end.
How Much Should I Pay?
Deciding how much you should pay is complicated because there is no hard and fast rule for how much you’ll owe. It depends on your tax bracket and other deductions and credits for which you might be eligible.
But remember, your estimated tax payments cover both income taxes and self-employment taxes. For 2018, self-employment taxes are 15.3% of your net self-employment income. So whatever your estimated income taxes are, add an additional 15.3% to cover self-employment tax.
If you’re new to freelancing, you’ll need to come up with an estimate. This can be difficult if your income fluctuates and you don’t know what you’ll earn, but IRS Form 1040-ES can help walk you through the calculation.
The more organized you are, the easier this will be. Using accounting software can help you keep income and expenses organized and simplify the process.
Understanding the “Safe Harbor” Method
While estimating your tax liability can be complicated, the IRS allows you to use a “safe harbor” method. Use one of these methods, and the IRS will not impose a penalty, even if you’re underpaid at year end.
- 90% of the tax you owe for the current year. Estimate what you will owe this year and pay at least 90% of this amount in four installments. That number may be hard to predict if this is your first year freelancing or your income and deductions are irregular.
- 100% of last year’s taxes. If you’ve been freelancing for a while and your income is generally stable from year to year, you can pay the 100% of the tax shown on your prior year return as a safe harbor. Just take a look at Line 63 on Form 1040. This is the total tax you owed last year, before any estimated payments, withholding, or refundable credits were applied. Divide this amount by four and pay that quarterly. Note that if your adjusted gross income is greater than $150,000 (or greater than $75,000 if you are married but file separately from your spouse), the safe harbor is 110% of your prior year tax liability.
- Annualization income installment method. This is best for seasonal freelancers or people whose income rises dramatically late in the year. This method allows you to annualize your tax for each quarter based on an estimate of income and deductions rather than paying in equal installments. For example, if your estimated tax for the year is $20,000, but $15,000 of that comes from the last quarter of the year, you can use the annualized income installment method to pay as you go. To use this method, you’ll need to file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, including Schedule AI, with your return.
Keep in mind, though, that if you expect your income to be significantly higher than last year, you may want to pay in more than the safe harbor amount. These methods will help you avoid underpayment penalties, but if you could still end up owing a significant amount to the IRS at tax time.
Next Step: How to Plan for Quarterly Estimated Taxes
For many freelancers, the most challenging part of paying estimated taxes is having the cash available to make the payments when they’re due. Without a strategy, you can easily spend all of your cash paying bills or reinvesting in your business. So once you’ve figured out how much you should pay, you need to select a method for setting those payments aside. Here are a couple ways you can do that.
Make Monthly Transfers into a Savings Account
Let’s say you calculated your estimated tax for the year based on safe harbor method and decided you need to pay $20,000 per year, or $5,000 per quarter. That works out to $1,667 per month.
At the end of each month, you transfer $1,667 to your savings account, where it will sit until it’s time to pay your quarterly estimates. Set a reminder on your calendar to do this at the end of each month or automate the transfer through your bank. You can either park this money in your regular savings account or put it in a separate account that you never touch unless you’re paying taxes.
Alternatively, Transfer a Percentage of Each Payment into Savings
If your income fluctuates from month to month, it might make more sense to transfer a portion of each payment you collect into savings. First, you’ll need to calculate your estimated tax for the year, then figure out what percentage of your net income that represents.
For example, let’s say your income for the year will be approximately $100,000 and you estimate your tax liability, including income and self-employment taxes, to be $20,000. That’s 20% of your income. So each time you collect a payment from a client, you would transfer 20% of it into your savings account.
This strategy doesn’t take into account any expenses that might be used to offset your income. If you have a lot of expenses, this strategy might mean you overpay your taxes. However, you can have that overpayment applied to next year’s tax liability, which will reduce your quarterly estimates next year.
Also, if you collect a large number of small payments each month, this method can be time-consuming. You may be able to save time by automating the process through your bank or a savings app.
When Are Quarterly Estimates Due?
Quarterly estimates are generally due on April 15th, June 15th, September 15th, and January 15th of the following year. If one or more of those dates fall on a Saturday, Sunday, or legal holiday, the payment is due on the next business day.
You can mail your quarterly estimates to the IRS using the vouchers included with Form 1040-ES, or pay online using IRS Direct Pay.
Keep in mind that depending on where you live, you may also need to pay quarterly estimated income taxes to your state and city. Each jurisdiction has their own rates, forms and sometimes different due dates, so do some research with the Department of Revenue or work with your tax professional to make sure you’re covering all of your bases.
Prioritizing quarterly estimated tax payments can be tricky when dealing with a variable income – especially if this is your first year freelancing. But diligently tracking your income and expenses and setting aside tax payments can take some of the bite out of tax time.
After the first year, you’ll have a better idea of your safe harbor tax payments and a system in place to make it all run smoothly.
about the author
Janet Berry-Johnson, CPA, is a freelance writer with over a decade of experience working on both the tax and audit sides of an accounting firm. She’s passionate about helping people make sense of complicated tax and accounting topics. Her work has appeared in Business Insider, Forbes, and The New York Times, and on LendingTree, Credit Karma, and Discover, among others. You can learn more about her work at jberryjohnson.com.