The only things in life that are guaranteed are death and taxes, and even if you don’t have an employer who deducts taxes from your paycheck automatically, you’re still required to give the IRS a cut of your cash. This can be done through estimated quarterly tax payments in addition to tax season. Understanding and accurately estimating how much you owe will help you avoid incurring penalties from the IRS and can lessen your chance of being audited. Use our step-by-step guide to start making estimated monthly payments today.
Why do I Need to Make Estimated Quarterly Payments?
The government knows that most people are pretty bad at managing their money. They tend to spend all of their paycheck as soon as they get it and may not put as much into their personal savings accounts as they should. This is why, when you are an employee, your employer is required to deduct taxes from your paycheck every month. The government wants to make sure that it gets its tax money, and it doesn’t want to run the risk of hoping you’ll pay it back at the end of the year.
When you are self-employed, you don’t have an employer who’s responsible for deducting your taxes automatically. Estimated quarterly payments are your way of ensuring the IRS that you’re not spending the money you would normally pay them from your standard paycheck, and that you can cover your self-employment taxes, Social Security tax, and Medicare contributions.
Who Needs to Pay Quarterly Taxes?
As a general rule, there are usually three groups of people that need to make estimated quarterly tax payments:
- Self-employed individuals, freelancers, and sole proprietorship business owners: If you own a business or are self-employed and expect to pay at least $1,000 in taxes for the coming year, you are required to make estimated quarterly payments.
- Corporation owners and partners and S corporation shareholders: Business ownership and partnership, including partnership in an LLC, comes alongside estimated quarterly tax payments. If corporations expect that they will owe at least $500 in taxes at the end of the year, they are required to make estimated quarterly payments.
- Men and women who owe back taxes: If you owe back taxes from the previous year, you will be required to make quarterly payments to absolve your debts and ensure the IRS that you are making a serious attempt to pay everything you owe.
You do not need to make estimated quarterly payments if:
- You are an employee: If you are an employee, your employer is required to withhold taxes on your behalf. You’ve probably already noticed deductions for Medicare, Social Security, and federal taxes if you've taken a close look at one of your pay stubs. Make sure you fill out your Form W-4 correctly before submitting it back to your employer to ensure that they are taking the right amount of tax out of your paychecks.
- You meet very specific criteria: If you were a U.S. citizen or resident for the entirety of the last year and you owed no taxes, you do not have to make estimated quarterly payments.
How to Set up Estimated Quarterly Payments
Follow these steps!
Step 1: Calculate how much you owe
To calculate how much you owe, you’ll first need to estimate your total taxable income. Taxable income is all of the money you made, less the deductions you anticipate to qualify for this year. If you are itemizing your deductions, sort through your expenses and estimate your deductions for office supplies, materials, transportation, and anything else that qualifies.
If you aren’t itemizing, you can also choose to take the standard deduction of $12,000 for single filers or $24,000 for married couples filing jointly. You may also deduct any above-the-line deductions for the year, which can include contributions to a traditional IRA, interest on student loans, certain expenses for books and supplies incurred by teachers, and more.
Determine your tax bracket using your taxable income. Then subtract both the percentage you pay in income tax according to your tax bracket and the current rate of self-employment tax — for 2019, you’ll be taxed at 15.3 percent. As an example, let’s say you made $100,000 last year and you had $20,000 worth of deductions. Your taxable income would be $80,000, which would put you at an income tax percentage of 22 percent for taxes filed by April 15th, 2019.
This means that you would owe $4,453.50 plus 22 percent of any money you made past the lower end of the bracket, $38,700. $80,000 minus $38,700 equals $41,300. $41,300 times .22 equals $9,086. $4,453.50 plus $9,086 equals $13,539.50 due in income tax. Now, calculate your self-employment tax simply by multiplying your taxable income times 15.3 percent. $80,000 times .153 equals $12,240. $13,539.50 plus $12,240 equals $25,779.50, your total tax liability for the year.
As its name suggests, quarterly payments are paid out once every three months. To estimate how much you should pay each quarter, simply divide your total tax liability by four. In this example, you would be paying about $6,444.88 per quarter. What should you do if you have no idea how much money you made last year? There is a caveat you can use called the safe harbor rule that will protect you from fees or penalties from the IRS for over or underpaying.
Simply pay 100 percent of the tax that you paid last year on a quarterly schedule. If your income has grown, you will be billed during tax season for the outstanding amount less what you’ve already paid but you will not incur fees that you normally would for underpaying the IRS. One important thing to note: if you made more than $150,000 this year, you’re required to pay 110 percent in what you paid in income tax last year to be protected by the safe harbor rule.
Step 2: Fill out a Form-1040ES and submit it to the IRS
Calculating your estimated payments is the most difficult part of the process. After you’ve got that figured out, all you have to do is file a Form-1040ES and mail it to the IRS location closest to you along with your first check. If you want to pay via direct deposit, you may do so by authorizing quarterly withdrawals from your account via the IRS Payment Gateway.
Step 3: Figure out your state taxes and set up quarterly payments
The steps listed above cover only your federal income tax dues; they do not cover your state income taxes. You cannot submit your federal and state income taxes via the same form or at the same address. The following seven states do not impose a state income tax:
- South Dakota
If you do not live in one of the aforementioned states, you’ll also be responsible for paying quarterly taxes to your state’s government as well as the IRS. The specific procedures to file state taxes depend upon your individual state’s income tax rates and the state you’re living in. To learn more about filing quarterly payments on the state level, check out our crash course in how to file state taxes here.
Step 4: Understand the quarterly schedule and avoid fees
The IRS can impose a number of penalties on you for failing to pay quarterly taxes on time, or for paying too much or too little in taxes throughout the year. Remembering to schedule your payment before the due date can ensure your money arrives on schedule and that you aren’t charged a late fee. Estimated quarterly tax deadlines are as follows:
- For any money made between January 1st and March 31st: April 15th
- For any money made between April 1st and May 31st: June 17th
- For any money made between June 1st and August 31st: September 16th
- For any money made between September 1st and December 31st: January 15th of the following year
If you use direct deposit to submit your payments, you may want to schedule your withdrawal to occur a few days before the due date in case a computer error or attack on your bank’s electronic system delays transfers. If you are mailing a paper check to the IRS, remember to double-check the address before you mail the letter and mail your payment at least a week before the due date.
As you can see, filing taxes can be an expensive and time-consuming process for self-employed individuals. The best way to lower your tax burden when Tax Day arrives is to make sure you are keeping careful records of all your expenses and deductions. That stack of $5 “thank you” notes you sent to clients, or that $10 pack of pens you picked up at the drugstore, might seem too insignificant to write down and deduct. However, many business owners and contractors are surprised to see how keeping a budget of these running costs quickly pile up and form significant deductions.