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Freelancer’s Guide to Quarterly Estimated Taxes

Freelancer's Guide to Quarterly Estimated Taxes

Today is September 17, the day third quarter estimated taxes are due for 2018. If you’re anything like me when I first started freelancing you are either

A) Not even sure what quarterly estimated taxes are or if you owe them
or
B) Scrambling to pay last minute but can’t figure out how to do it online

So let’s address both. Keep in mind I’m not an accountant or IRS employee, just a marketing consultant and blogger who’s been freelancing for more than three years.

Scroll down to learn how to EASILY calculate your quarterly tax payment!

 

The Freelancer's Guide to Quarterly Estimated Taxes

A) What are quarterly estimated taxes, and do I have to pay them as a freelancer?

Quarterly estimated taxes are payments you make four times a year (hence, quarterly) to the IRS for the tax you have to take out of your income from clients. Does this seem unfair? Not at all.

Let’s zoom out and look at the big picture of why we even pay taxes!

As citizens of a country with a government that provides services to us, we pay taxes to cover those services (such as maintenance work that keeps our roadways safe and police officers who enforce our laws). One of the ways we pay is through income tax.

As an employee, your income tax would be taken out of your paycheck before it ever hits your bank account (something known as “withholding”). As a freelancer, YOU are responsible for taking that income tax out of your clients’ paychecks (something known as “estimated tax payments”). So it just seems more painful as a freelancer because you see it, whereas an employee you don’t, so you tend to forget it’s happening.

Every April 15, what we so affectionately call Tax Day, is basically a reckoning with the government to see if

  1. We get a refund, which means we paid too much in withholding or estimated taxes and the government owes us.Or
  2. We owe taxes, which means we paid too little through withholding or estimated taxes and we owe the government.

The Due Dates for Quarterly Estimated Tax Payments

For the year 2018, they are:

April 17, 2018

June 15, 2018

September 17, 2018

January 15, 2019 (That’s right, you make the last payment for the current tax year in the first month of the following year.)

Do I owe quarterly estimated taxes?

Probably. No matter if you freelance part-time or full-time, you must pay quarterly estimated taxes if you expect to owe $1,000 in tax. Here’s what the IRS has to say:

“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.”

But how do you know if you’ll owe $1,000 in tax? A quick and dirty way is to look at your previous year’s tax return. If you owed $1,000 or more last year, then you’ll likely need to pay quarterly estimated taxes this year. But if you didn’t freelance last year or your freelance income is significantly different this year, then that doesn’t help much. I found this quarterly estimated tax guide by Freelancers Union very helpful, particularly this quote:

“That’s very hard to calculate, and depends on your tax bracket. Remember you will be paying at least 15.3% of freelance income in taxes (self-employment tax), so if you’re making more than $15,000 freelancing, you will probably need to pay quarterly taxes.”

For all the nitty gritty details, please visit the IRS website or even better, consult an accountant.

How do I calculate how much estimated tax I should pay each quarter?

That question is tricky to answer because the answer varies dramatically depending upon your individual circumstances.

To figure out how much estimated tax you owe, fill out the 1040-ES form.

Admittedly, that form is complicated, so I also highly recommend consulting an accountant. The easiest way (and the way I do it) is to have an accountant prepare your income tax return for you come March or April. When they calculate any income tax you owe for the previous tax year, they will also make quarterly estimated tax payment vouchers for you to mail for the current tax year.

I also found this article about how to estimate quarterly taxes very helpful.

Now, as a freelancer, it may be tricky for you to estimate how much you’ll earn, as you may go through dry periods. But don’t worry! As long as the total of the four quarterly estimated tax payments for this year equals at least 90% of the amount of income tax you owe this year, you will not be charged a penalty.

As the IRS website states:

“Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.”

The EASIEST Way to Figure Out How Much to Pay in Quarterly Taxes Each Quarter

Here’s my simplified formula for calculating quarterly estimated tax payments:

([Your Total Business Revenue for the Quarter] – [Your Total Business Expenses for the Quarter]) X .3 = Your Estimated Tax Payment This Quarter

* Multiplying by .3 represents the roughly 30% in taxes you can expect to pay on your income. That number varies widely depending on your income, where you live, etc. Most experts recommend setting aside 25% so if you do 30% you should be really safe. If you overpay, you’ll get a refund from the IRS come Tax Day.

Knowing which numbers to plug in depends on the quarter. So you need to know this (courtesy of Yale)

  • Q1 Tax payment (April 15) covers January 1-March 31
  • Q2 Tax payment (June 15) covers April 1-May 31
  • Q3 Tax payment (September 15) covers June 1 – August 31
  • Q4 Tax payment (January 15) covers September 1 – December 31

EXAMPLE: Let’s say I want to pay my quarterly tax payment for September (which is Sept. 17 for 2018)

I would go into my bank account or PayPal account that I use for business only, and look at how many deposits were made from June 1 to August 31. Let’s say I had $5,000 in revenue.

Then, I’d filter by withdrawals to see my business expenses. Let’s say I spent $1,000 on my business from June 1 to August 31.

By plugging the numbers into the formula: ($5,000-$1,000) x .3 = $1,200.

My quarterly tax payment on Sept. 17 is $1,200.

But what if I mess up and don’t pay enough, or what if I miss a payment?

While this is poor practice, again, don’t worry too much. The penalty for late estimated tax payments is very low, so it’s likely to be in the tens of dollars, not the hundreds (again, it really depends on how much money you’re making). Having said that, it is still of course best to pay on time and not have to pay any additional fees to the government. Here’s what the IRS website says about penalties for late payment:

“The late-payment penalty is 0.5% of the tax owed for each month or part of a month that the tax remains unpaid after the due date, up to 25%.”

What if I mess up and pay more than I actually owe?

Then you’ll get a refund come April 15.

B) How do I pay my quarterly estimated taxes? Can I do it online?

The old-school way is to print out paper vouchers that you can then mail in to the IRS, but I prefer doing it online.

The IRS has two options for you to pay your quarterly estimated taxes online:

Option One: Directly from your checking or savings account via IRS Direct Pay

Step 1: Visit the IRS Direct Pay site and select “Make a Payment.”

How to pay quarterly estimated taxes online step 1

Step 2: Select 1040, Estimated Tax, and the current year.

How to pay quarterly estimated taxes online step 2

Step 3: You’ll have to verify your identity with tax info from previous filings.

How to pay quarterly estimated taxes online step 3

Step 4: Enter your checking or savings account information and schedule your payment.

How to pay quarterly estimated taxes online step 4

IMPORTANT INFO ABOUT SCHEDULING AN ON-TIME PAYMENT: If you try to schedule a payment the DAY the ESTIMATED TAX IS DUE, you will NOT be able to do it! That’s because you need to schedule a payment at least 24 HOURS IN ADVANCE. However, not to worry! The IRS site clearly states that even if you schedule it for the day AFTER IT IS DUE, you will NOT be charged penalties. See screenshot below:

Paying estimated taxes online IRS website

OPTION TWO: From your debit or credit card via third-party sites approved by the IRS.

Keep in mind you’ll pay extra fees for doing this. The lowest debit card convenience fee you’ll pay is a flat $2.59. However, using a credit card incurs a percentage fee, and the lowest is 1.87%.

Should I pay my quarterly estimated taxes with a credit card?

There may be a couple of reasons why you’re tempted to pay your estimated tax payments with a credit card such as

  • You don’t have the money to pay the tax you owe right now
  • You want to hit a minimum spend for a signup bonus

However, you really should think twice about charging taxes to your card.

First of all, if you don’t have the money to pay the IRS right now, you should contact them via website or phone to work out a payment plan. They are very understanding, and their interest rates are WAY lower than the interest you would pay on a credit card!

Second, if you want to hit a minimum spend, consider if there are other ways to hit that spend other than paying your estimated taxes. Consider the fact that the lowest convenience fee you’ll pay for a credit card through one of the third-party sites is 1.87%. That means if you owe $3,000 in quarterly estimated taxes, and you use a credit card to pay it because you want to hit a minimum spend, you’ll get charged $56.10 in convenience fees for paying your taxes! Really consider if it’s worth paying extra just to get a signup bonus.

As always, you should only ever charge to a credit card if you have the money to pay it off!

What should I do if I don’t have enough money to pay my taxes?

If you skipped paying quarterly estimated taxes all year and come April 15, you owe more than you can pay, here’s what you should do:

  1. You STILL should file your tax return on time. There is a penalty for not filing your return, in addition to a penalty for not paying it.
  2. Pay as much as you are able to now, to avoid as much interest as possible.
  3. Let the IRS know, so you can work out a payment plan or installment agreement. Details on that here.

Pro Tip: How to Avoid Not Having Enough Money to Pay Your Taxes

When I first started freelancing, I ALWAYS came up short when it came time to pay my income tax return. Why? Simply because I wasn’t SETTING ASIDE my TAX MONEY. Again, as an employee, your income tax would be taken out of your paycheck before you ever got it. This means, as a freelancer, you NEED to set aside money for your taxes. I would recommend at least 25%. I set aside 30% to be safe (and because I live in California, a high-tax state).

CHANGE YOUR MENTALITY. For example, if you get a paycheck for $1,000 from a client, you DID NOT MAKE $1,000, you made $750 (25% goes to the government for income taxes, remember?). So always take out a chunk of every income source and set it aside in a SEPARATE bank account for your income tax. I put mine in a savings account with the bank I use for my business account. My personal checking and savings account is with a completely different bank.

I hope this helped shed some light on a murky subject. Now go out there and pay your taxes! :)

*Disclosure: I am not an accountant, so this blog post should NOT substitute seeking professional advice from one. The U.S. income tax system is complex and you’ll need advice for your personal situation.

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