Self-employment certainly has its benefits. You can set your own hours, conduct business as you like and wake up every day knowing that the harder you work, the more successful you're going to be—capitalism doesn't get any simpler than that. Along with all the benefits, however, come several challenges, one of the most daunting of which is the U.S. tax system.
Many self-employed Americans, generally those earning more than $1,000 per year, are required to file quarterly estimated tax returns or risk facing significant penalties. The IRS tends to target these returns for auditing, making it critically important that you not only file on time, but that you file correctly.
If you haven't already done so, sit down and estimate how much you owe, how to pay and how to budget for next quarter's payment. The sooner you start planning, the better off you'll be.
1. Estimate your income to the best of your ability. If you like working within an intuitively structured system, chances are, you're not going to enjoy filing quarterly taxes. The deadlines are set up so that some fall before quarters pass and others fall after. So, first things first. Input the following deadlines into your electronic or paper calendar:
- 1st Quarter: April 15
- 2nd Quarter: June 15
- 3rd Quarter: September 15
- 4th Quarter: January 15
These are the due dates every year except when these dates fall on a Saturday, Sunday or legal holiday. In these cases, the payment is considered on time if it is made the next day that is not a Saturday, Sunday or legal holiday.
For deadlines that fall before the quarter in question ends, you're going to have to do your best to estimate your income. Take into account any invoices you expect to be fulfilled and base your short-term earnings on former experience to the best of your ability.
2. Compute your payment accurately. If you don't have a lengthy income history to base your estimations on, or if it varies dramatically from year to year, calculating your payment can be a challenge. Self-employed Americans need to pay both the employee and employer portions of the Social Security and Medicare tax, also known as self-employment tax, which is 13.3 percent in 2012. You are, however, allowed to deduct half of the self-employment against your income, reducing your total tax requirement.
3. Include taxes in your monthly budget. If you don't budget for your quarterly tax payments, you could experience a financial roller coaster ride four times every year. Instead of simply planning to absorb a significant hit every three months, consider pro-rating an estimated monthly amount into your personal budget. You will encounter fewer surprises and make managing your finances much less stressful. If you don't currently use a personal budget, especially as a self-employed worker, you're asking for trouble.
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4. Pay online. Gone are the days of waiting in line at the post office for that return receipt stamp. You can now make quarterly tax payments online via the Electronic Federal Tax Payment System. Just register, link a bank account and submit your payments electronically. If you're using this service for the first time, however, you're going to have to set up a PIN in order to make a payment. This typically takes a few days to arrive, so don't wait for the last minute to sign up. You can consult Form 1040-ES or a CPA for further details.
Estimate and Plan
Always make liberal estimations when your taxes are concerned. Generally, you won't be penalized if you owe less than $1,000 by the end of the year, you paid at least 90 percent of your tax bill throughout the year, or you paid 100 percent of the taxes you owed for the prior year.
Of course, it's always prudent to maximize your business and personal credits and deductions to help lower your tax bill. Take some time and familiarize yourself with the wide range available to you—even if someone else handles your taxes. Start by reviewing IRS Form 1040 as well as Schedules A and C at the IRS website for additional deductions that may be available to you. By planning ahead and knowing all the money moves you can make year-round, you could significantly reduce your tax bill, and better plan your quarterly payments.
Have you had any issues with quarterly tax payments?
Read more articles on small-business finance.
A graduate of Brown University, Andrew Schrage was formerly an analyst at a hedge fund and later went on to co-found the personal finance resource, Money Crashers Personal Finance.