How to Manage Estimated Quarterly Taxes as a Freelancer
If you're a freelancer, chances are you receive your income straight up — that is there are no taxes taken out of your “ paycheck.”
You probably completed what's called a W-9 form for your client or clients which lets them know that you are not a W-2 employee and taxes should not be taken out of your paychecks.
Contrary to popular belief, you didn't figure out a way to earn money tax-free.
Though it’s great that you are able to earn money independent of a salaried-job, you haven’t hit the lottery.
More often than not, there’s no such thing as tax-free ordinary income.
In fact, as a freelancer or self-employed person, you are responsible for paying your own payroll taxes.
You’ve also got to comply with state and federal wage reporting requirements.
Taxes Owed by Freelancers/Self-Employed
According to the IRS website, you are self-employed (and thusly required to pay self-employment and income tax) if:
- You carry on a trade or business as a sole proprietor or an independent contractor.
- You are a member of a partnership that carries on a trade or business.
- You are otherwise in business for yourself (including a part-time business)
If any of these scenarios apply to you, you must file an annual tax return and pay estimated quarterly taxes.
Two types of taxes
As a freelancer or self-employed person, you are actually required to pay two types of taxes.
You must pay what is called self-employment tax, as you are essentially acting as your own employer.
In addition to that, you are required to pay income tax.
Self-employment tax covers Social Security and Medicare tax.
This is similar to the same taxes that would be withheld from your paycheck as if you were a W-2 employee for a business or company.
The current rate is 7.65% for both Social Security and Medicare taxes. This means you’ll pay your self-employment tax at a rate of 15.3%. That rate is the sum of a 12.4% Social Security tax and a 2.9% Medicare tax on net earnings. Self-employment tax is not the same as income tax.
You should also know that Social Security portion is only paid on the first $147,000 of your income, it rises to $160,200 in 2023.
Also, you do get to deduct the employer-equivalent (what you cover as your own employer,) of your self-employment taxes when you are tallying-up your taxable income figures.
In terms of income tax, this is the amount of taxes you will owe based on your tax bracket.
2022 Tax Bracket
|Marginal Tax Rate||Single||Head of household||Married (filing jointly)||Married (filing separately)|
|37%||Over $539,900||Over $539,900/||Over $628,300||Over $323,925|
So though you do have to pay two taxes, the good news is that there are some limits and deductions that could lessen the sting of paying both self-employment and income tax.
The Rules for Estimated Quarterly Taxes
Now that you know you are responsible for paying and filing records regarding taxes, you should know a little more about the estimated quarterly taxes rules and requirements.
As a self-employed person, you are required to file an annual return like W-2 employees.
In addition to this requirement, you’ve got to file and pay on what are called estimated quarterly taxes.
This rule applies to U.S. citizens and resident aliens.
If you are a resident of Puerto Rico, the U.S. Virgin Islands, Guam, the Commonwealth of the Northern Mariana Islands, and American Samoa, estimated quarterly taxes will also apply to you as a freelancer.
Fees, fines, and penalties
These filings are important because you could be subject to fees, fines and, penalties if you pay or file past the deadline.
You also could be charged a penalty if your estimated tax payments are late, even if you should get a refund when you file your tax return.
There could be a problem if you don't pay enough estimated tax throughout the year. If this happens, you could have to pay a penalty for underpayment of your estimated taxes.
However, you could avoid this penalty if you owe less than $1,000 in tax (as calculated by subtracting withholdings and credits, or if you paid at least 90% of the tax for the current year, or 100% of the tax shown on the annual return filing).
There are exceptions to penalties if you are in certain industries, have irregular income, recently retired, recently became disabled, or encountered a natural disaster.
The IRS will also take other reasonable circumstances into consideration - as long as they can determine that failure to pay the full tax amount was not due to willful neglect or fraud.
How to Calculate How Much to Set Aside
According to the IRS, you can calculate your estimated taxes using the 1040-ES form.
The form includes a worksheet that will help you estimate your adjusted gross income and related deductions to arrive at your taxable income amount.
Your estimated tax will need to cover self-employment tax and income tax.
In order to avoid penalties, have your last year's return available to help you get the best figures for your estimated payments.
To figure out the taxes you'll owe, you need to take your annual gross income, that is, all of your business receipts (plus any other income you receive like from sources like interest, dividends, rents, alimony, etc.) Then, deduct any expenses you qualify for.
For example, if your business revenue is $150,000 and your deductions come out to $50,000 for the year, your taxable income will be $100,000.
From this point, you use the 1040-ES form to figure out the amount of self-employment and income tax owed based on your taxable income.
You'll divide the final tax amount owed by four and submit those four payments on a quarterly basis according to the estimated payments due dates:
- Estimated taxes for income earned between January 1 and March 31 is due April 15
- Estimated taxes for income earned between April 1 and May 31 is due June 15
- Estimated taxes for income earned between June 1 and August 31 is due September 15
- Estimated taxes for income earned between September 1 and December 31 is due January 15 of the following year
Where Should One Keep the Funds For Taxes?
Though you could place funds aside for tax payments in either a personal checking or savings account, the best practice would be to place your taxes in a business account.
This business account could be a checking or savings account.
If you are able to get a business savings account with low or no monthly fee, it may be better to place your income tax payments there.
This way, the money is earmarked for tax payment and will not be inadvertently spent in your business checking account
Once you put the money in a business savings or checking account, you should be able to draw checks or make electronic payments from it.
Another alternative would be to transfer money from your business savings account to your business checking account right around the time you’ll pay your taxes from your business checking account.
How to Pay Quarterly Taxes
There are many convenient ways to pay your estimated quarterly taxes.
You can get all the details about processing times, fees, limitations and other rules for each payment method from the IRS payment website.
- IRS Direct Pay: Comes directly from your checking account with no charge.
- Pay by Card: You can use a credit or debit card, but a convenience fee will apply.
- Electronic Fund Withdrawal (EFW): This is available for e-file/e-pay when you use tax software to handle your filings.
- Online Payment Agreement: This is available if you cannot pay your taxes in full by the due date. You can make an arrangement to pay your balance in installments. There is a user fee associated with this payment method.
- IRS2Go: The IRS mobile payment app which lets you access Direct Pay or Pay By Card options via mobile phone.
- You can use a debit or credit card
- You can pay via the Electronic Federal Tax Payment System (EFTPS)
You must register with the IRS payment handler, Official Payments, first. There is a $1,000 per day payment maximum on this payment method.
Check or money order
Use the Estimated Tax payment voucher found on the 1040-ES form.
Each state will have its own guidelines and requirements, so check with your state’s department of revenue to find out more about self-employment and income tax regulations.
If you feel like you are not organized enough or perhaps don't have the time or bandwidth to handle your quarterly estimated tax payments and filings, you could pay an accountant or bookkeeper to handle this process for you.
You will simply have to give them the information that they would need to complete the filings and payments for you.
Also, there are self-employment payroll services that you can use that will calculate, pay and file your estimated quarterly taxes.
Being in business for yourself can be hard. Not knowing about the rules and regulations around tax filings could definitely make your life harder.
Though it might seem daunting calculate, file and pay your taxes, in the beginning, it's worth it to educate yourself then choose the process that works best for you.
Even if you have to pay for help or engage a service, it will be well worth it so that you don't owe penalties that could cancel out the benefits and profitability of being in business for yourself.