If you are on a company’s payroll, you usually don’t have to worry about taxes until the first few months of the following year. Your employer withholds the taxes based on the allowances you claimed when you filled out Form W-4. But if you make money outside of a traditional job, you’ll be responsible for paying all your own taxes. If you wait until tax time, you’ll find you owe taxes for every dime you made throughout the year, along with penalties. For that reason, self-employed people generally pay advance taxes, also known as estimated tax payments.
To pay advance taxes, you’ll first need to calculate quarterly payments, then remit the amount due on the four due dates spread throughout the tax year.
How to Make an Advance Tax Payment
If you use a tax preparer or tax preparation software, you’ll likely get advice on what you should pay each quarter to reduce your risk of owing during the next filing season. This is an estimate, based on how much you made during the previous tax year. The problem with this, of course, is that many self-employed professionals don’t make a predictable income year after year. If they work on a freelance basis, they may lose a big job or land a lucrative new client. They may create a new product that takes off and bring in far more income than they expected.
However, from one year to the next, you can get a rough estimate of how much you’ll owe in taxes based on last year’s earnings. As you see your income exceed or fall short of that, you can always adjust your quarterly payments as needed. Even though your tax preparer will give you an “amount due” for each quarter, this is not set in stone. If you have a slip you mail with your payment, you can just cross out the amount and write in the total amount of money you’re remitting.
Paying Estimated Taxes
Even if you’re on salary somewhere, if you earn money on the side without taxes taken out, you’ll need to track the money you make. Whether it’s $1 or $100,000, you’re supposed to report every dime to the IRS by the mid-April filing deadline. For sole proprietors, though, you won’t be required to make estimated tax payments unless you think you’ll owe $1,000 or more. This doesn’t include any withholding or refundable credits.
If you have a day job where taxes are withheld, you can alternatively increase your withholdings there to avoid paying quarterly taxes. If you calculate it correctly, you’ll have enough taken out of your paycheck to cover the money you’re making on the side.
Why Pay Estimated Taxes?
Before proceeding, it can help to understand why self-employed professionals pay taxes ahead of time. Since no one is taking money out of your pay to ensure your Social Security and Medicare taxes are taken care of, when you don’t pay estimated taxes, you’re holding on to money that the IRS could have earned interest on throughout the year. But if you didn’t pay quarterly taxes, you aren’t alone. In fact, the number of people who owe penalties due to errors and estimated tax underpayments has risen almost 33 percent since 2007. This has been blamed, in part, on the large number of gig economy workers who simply have no idea they’re supposed to be paying quarterly.
But you do have a little leeway when it comes to paying your taxes. If you owed less than $1,000 after subtracting your withholdings and credits or paid at least 90 percent of your taxes for the tax year, you’ll get a pass. If you are found to owe for underpaying estimated taxes, the penalty is in the 3-5 percent range, varying from one year to the next, and the IRS does not compound interest for estimated tax underpayers as it does for late filers.
How to Estimate Advance Tax Payments
You don’t need a tax preparer to estimate how much you owe in taxes. The IRS provides a worksheet that walks you through calculating how much to pay. You’ll input your anticipated earnings for the year and determine whether you need to pay estimated taxes at all. For the 2018 tax year, you’ll be taxed on wages up to $128,400 and the self-employment tax is still 15.3 percent, which includes Social Security and Medicare taxes.
Although the Estimated Tax worksheet can be helpful, as the year progresses, you may want to revisit what you’ve input there. If you’re tracking your earnings, you can monitor what you’re paying every few months in taxes and make sure it covers at least 15.3 percent of what you’re making. Keep in mind, though, that you may have deductions that reduce the amount of your income that’s subject to taxes in April, so if you fall a little short in one or two quarters of the year, you may make up for it that way.
When Are Quarterly Payments Due?
There are different due dates depending on how your particular business is classified. For sole proprietors, though, estimated taxes are due in mid-April, mid-June, mid-September and mid-January. The due date is the 15th of each of those months unless the 15th falls on a weekend or holiday, at which point it is moved to the following Monday. Yes, if you are a sole proprietor and you owe on your annual taxes in mid-April, you’ll also be expected to remit a quarterly payment at the same time to satisfy next year’s tax requirements.
Businesses that employ workers have a few other dates to note. At the end of January, 1099-MISC forms are due to contractors, with those forms due to the IRS by the end of February. In mid-March, S Corps must pay their taxes, and personal income taxes are due on April 17. Businesses that pay sales tax will also find that they have tax due dates. Those vary depending on municipality, but companies that do a high volume of sales are often required to remit tax payments on a monthly basis.
How to Pay Estimated Taxes
Form 1040-ES is the document you need to estimate your quarterly taxes. This form comes with four payment vouchers that you can mail in with your payment. Each voucher includes the due date and instructions on how to make out your check. Each time you pay advance tax, you should mark it on the included Record of Estimated Tax Payments. You’ll need this at tax time so that you can get credit for the taxes you’ve already paid when you file.
But you don’t have to mail in the included slips with a check. In fact, the IRS offers multiple ways to pay, including IRS Direct Pay, credit or debit card, electronic fund withdrawal and an online payment agreement. If you aren’t comfortable paying through the IRS website, you can call one of the IRS’s authorized service providers and provide your credit or debit card information. It’s important to note that you’ll pay a flat fee of up to $3.95 plus 1.87 to 1.99 percent to use plastic. Since this can add up for higher tax payments, it might be worth investigating one of the other payment types.
Reducing Your Taxes Due
If you arrive at the end of the year and realize you didn’t pay sufficient taxes, it may be a good time to assess what you need for the upcoming business year. If, for instance, you planned to buy a new laptop, purchase it by Dec. 31 to claim it on your taxes for the current calendar year. A tax preparer or good preparation software can help you identify various items you can deduct, but here are a few items that are often deducted by sole proprietors and small-business owners:
- Home office: If you work from home, consider the area where you work. Simply calculate $5 per square foot and include it on your itemized deductions. However, you’ll need to make sure the space meets the IRS’s requirements, including being used regularly and exclusively for business purposes.
- Business equipment: Thanks to the new tax laws, you can now claim up to $1 million in capital expenses related to your business, including computers and furniture. This is up from $510,000 in 2017.
- Automobile: If you purchase a car for work use, you can deduct up to $18,000 the first year. However, you may be required to prove the vehicle is used solely for business purposes if you’re ever audited.
- Miscellaneous utilities: Sole proprietors and small-business owners who work from home can deduct cell phone and internet costs, as well. If you use the items for both business and personal, the IRS advises calculating the percentage used for each and only deduct the business portion.
- Health insurance: If you’re self-employed, you may be able to deduct the cost of your medical premiums, provided you have no other health insurance coverage.
- Trade books and publications: Anything you purchase to better yourself in your career may be claimable on your taxes. This includes books and magazines.
- Travel and meal costs: If you travel for business purposes, you can deduct the cost of transportation and accommodations on your taxes. Under the new tax law, however, you can no longer deduct entertainment expenses and deducting meals can get sticky. You’ll no longer be able to claim 100 percent of meals you buy for the convenience of employees – for instance, those pizzas you ordered for employees working late on a Friday evening. You can deduct half of that expense on your taxes and starting in 2025, you won’t be able to claim the expense at all. So far, though, you can still claim half of any meal expenses you collect while traveling.
Deducting Your Advance Payments
When April arrives, you’ll need to make sure you have a record of each of the IRS advance payments you made throughout the year. Your tax preparer will total these quarterly payments and let the IRS know that you made them. If you use tax preparation software, you’ll be asked to input these payments at some point, at which time you’ll be credited for taxes already paid. This is similar to the IRS giving salaried workers credit for the taxes taken out of their paychecks throughout the year. If you neglected to mark down what you paid each quarter, don’t panic. You can usually simply pull up your online banking app or look at your credit card statement and see exactly what you paid. You probably can even print out or save copies of your checks for your records.
If you’re doing your taxes on your own, you’ll simply total up the quarterly payments you made and input them on Line 65. If you’re owed a refund once you reach the end of the form, you can actually apply that refund to next year’s estimated taxes. You can either reduce the amount you pay each quarter or skip a quarter or two until the extra amount has been depleted.
- IRS: Estimated Taxes
- IRS: 2018 Form 1040-ES
- USA Today: IRS penalizes more earners for mistakes, underpayment in estimated tax filings
- IRS: Information About Your Notice, Penalty and Interest
- Visor: Tax Changes That Impact Freelancers in 2018
- Square: When are Quarterly Taxes Due: Dates to Circle in Red
- IRS: Simplified Option for Home Office Deduction
- IRS: Deducting Business Expenses
- Nolo: The Self-Employed Health Insurance Deduction: A Valuable Personal Deduction
- Indinero: What the Tax Act Means for Your 2018 Meals and Entertainment Deductions
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.