Everyday, more people are switching from full-time employment to freelance work. When they make the switch, it’s easy to overlook the requirement that self-employed people pay estimated taxes quarterly, not yearly as they did as full-time employees. Let’s take a closer look.
WITHHOLDING: THE IRS’S INSURANCE POLICY
When you’re an employee, your employer is required to withhold part of your paycheck for taxes. Essentially, you’re prepaying your taxes – and in many cases overpaying them, which means you’re entitled to a refund after you file your returns. This guarantees to federal, state and local governments that even if you fail to file your taxes at the end of the year, they’ve collected at least a fraction of your taxes upfront. It’s an insurance policy of sorts for the government.
On the other hand, when you’re self-employed, taxes are not withheld from your paycheck. You’re responsible for paying them yourself – which means that the government no longer has its normal insurance policy. Instead, it’s implemented a different insurance policy, which comes in the form of a requirement that the self-employed pay estimated taxes on a quarterly basis.
QUARTERLY TAX FILINGS
April 15 is notorious for being tax filing day. But if you’re self-employed, it’s only one of four filing days every year. Every quarter, by set dates, you must file IRS Form 1040-ES, Estimated Tax for Individuals, in addition to any state or local filings that may be required. You calculate your estimates based mostly on your previous year’s tax return.
April 15 is notorious for being tax filing day. But if you’re self-employed, it’s only one of four filing days every year.
If you expect to owe a small amount of tax at the end of the year or if the vast majority of your income is subject to withholding, then you may not need to pay estimated tax at all. Consult the IRS’s instructions for Form 1040-ES as well as the applicable forms for your state.
If you don’t pay – or underpay – your estimated quarterly taxes, you are liable for fines and penalties. The good news is, the IRS has several resources to help explain what you need to do and has made it easy to pay your estimated quarterly taxes online.
If you’re self-employed, it’s important you understand that the rules of the tax filing game aren’t the same as when you’re an employee subject to withholding. Take the time to get it right and save yourself from potentially expensive mistakes down the road.