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You’re self-employed for a reason. You like to set the rules and do your own thing. But when it comes to paying taxes, the IRS still rules the roost. So, you’ve got to pay income and self-employment taxes to Uncle Sam.
Those with conventional jobs get to sit back and let their employers take taxes out of each check. However, the self-employed must do that for themselves. Many ask whether they can pay at the end of the year or if they should send quarterly payments.
Mostly, self-employed workers should send estimated quarterly payments to the IRS. That said, some exceptions rely on your earnings and filing status.
If I’m Self-Employed, Should I Pay Estimated Quarterly Taxes?
Self-employed workers are business owners, company partners, independent contractors, and freelancers. A boss doesn’t tell them when to report to work or when they must work on projects. Freelancers and independent contractors have deadlines they have to meet.
However, a company can’t make contractors accept projects, and freelancers can always negotiate proposed deadlines. Self-employed people also receive gross pay or revenue. They are responsible for figuring out how much tax they owe after deductions.
The IRS prefers that business owners and independent contractors send estimated quarterly payments. However, the general rules apply to those who should pay quarterly:
- Business owners and freelancers estimate they’ll owe over $1,000 after annual deductions and credits.
- Deductions and tax credits will be less than 90% of your annual taxes.
- Deductions and tax credits will be less than 100% of your previous year’s taxes.
- If married and filing separately, high-income earners who make more than $150,000, or $75,000, must increase the third percentage to 110%.
Remember that quarterly payments are estimates of what you’ll owe on your annual income. Due to unpredictable income, some freelancers and business owners find this more difficult initially. However, you can figure your taxes based on last year’s earnings.
What Are the Pros of Paying Quarterly Estimates?
The IRS recommends using last year’s income to pay your quarterly estimates. You can use a worksheet that comes with the instructions for Form 1040-ES. The main advantage of paying quarterly estimates is that you don’t have to pay all at once.
Say you wait until the end of the year to pay what you owe the IRS on your self-employed earnings. You have to come up with all that money at once. But when you pay quarterly estimates, you’ve already paid the bulk of what you owe.
And if you’ve paid the IRS more than your tax obligation, you’ll get a refund. So, your tax-paying experience is closer to that of a W-2 employee. As a result, it’s easier to budget, and you don’t have to stress about paying a large amount of taxes.
If you’ve been in business or self-employed for less than a year, you don’t have to pay quarterly estimates. This is because there isn’t any baseline for reference. Wait until after your first year in business to make quarterly estimated tax payments.
What Are the Cons of Paying Quarterly Estimates?
While paying quarterly estimates of your annual tax obligation helps you budget, it can be inconvenient. You must file paperwork and send money four times a year and still calculate everything for your annual return. There’s also the chance you’ll under- or overpay.
Last year’s income is just that — last year’s earnings. When you’re in business for yourself, there’s no guarantee you’ll make the same. It’s not like earning a salary that doesn’t fluctuate much yearly. So, last year’s income may be higher or lower than this year’s.
That means you could send more money than you need each quarter. But, you won’t be sending enough on the other end of the spectrum. In the first scenario, this can impact a company’s or person’s financial stability.
For the second case, that person or business must now pay more cash to meet tax obligations. Plus, filling out paperwork and calculating revenues and deductions four times a year seems burdensome. That’s why self-employed tax software can be a lifesaver.
Taxes for the Self-Employed
When you work a traditional job, your employer deducts income taxes and other obligations like Social Security and Medicare. Business owners and independent contractors have to figure out these taxes separately. However, the IRS simplifies the process.
That’s why on Schedule C, you’ll see a section for self-employed tax. This typically covers Social Security and Medicare taxes. You can deduct half of your self-employment tax obligation from your gross income.
Other deductions include business expenses, supplies, and services you used to deliver your contract work. For example, say you have a paper route as an independent contractor. You can deduct the mileage you drove during the route from your gross proceeds.
Any other expenses, including insurance premiums and self-employed IRA or 401(k) contributions, also count as deductions. So, if your business earns $100,000 in annual revenue, you’ll rarely pay taxes on that total amount.
The Role of Deductions
As a self-employed person, you must keep track of income and expenses. Your tax obligation is based on net revenue, income, or profit. Carrying the above example forward, let’s assume you earn $100k from self-employment.
However, to provide those services or operate your business, you spend $50K. After deductions, your net income is $50,000. Now, let’s assume the self-employment tax rate is 16% on $50k; that comes out to $8,000. You get to deduct another $4,000.
In this scenario, you will pay income taxes on $46K of your earnings. Deductions help reduce your tax burden as a self-employed person. You don’t owe any taxes if you have a net loss from your business. A net loss means your expenses exceeded your revenues.
To take deductions, the expenses must be directly related to the operation of your business or contract work. For instance, you may have a home-based business. While you can take a home office deduction, this is a small or limited percentage of what you spend to maintain your house. This includes mortgage and HOA payments, property taxes, utilities, and upgrades.
Loans for Self Employed
You should pay quarterly estimates toward your annual tax obligation if you’re self-employed. For many reasons this may not always be easy. Keep in mind there are lenders such as SimpleFastLoans who offer loans for the self-employed to help with monetary issues associated with being your own boss.
Exceptions for your annual tax obligations exist for specific scenarios, such as being in business for less than a year and owing less than $1,000. Many self-employed workers find there are pros and cons to paying quarterly.
Advantages include spreading out the cost of your taxes instead of paying all at once. In addition, it’s easier to budget for tax obligations this way, and you could end up owing nothing at tax time. However, quarterly estimates require more paperwork and calculations.
You may also pay too much or little under the quarterly system. This is because you’re basing your estimates on the prior year’s income or revenue. As anyone in business knows, self-employed income rarely stays the same. So, quarterly estimates are not always the most accurate.