One challenge that self-employed people often run in to is making sure that they are accurately tracking and remitting their taxes throughout the year. Despite self-employment being a very rewarding experience, offering the opportunity to control your own time, pursue ambitious goals, and provide employment opportunities, it can also bring a lot of challenges. Learning how to make estimated tax payments can make one of those challenges much more manageable and help you stay on top of your taxes.
Key Takaways
- An important skill for self-employed people is knowing how to estimate and remit your taxes throughout the year.
- These need to be paid on a quarterly basis, following a schedule set out by the IRS.
- Failing to do so can lead to interest and penalties, and the requirement to make estimated payments can sometimes apply to people who are not self-employed.
Why You Should Make Estimated Tax Payments
Even though we file our tax returns once per year, we are technically required to pay taxes on our income throughout the year. For employees, this is accomplished through the withholding taxes that their employers remit on their behalf. But for self-employed people, it’s necessary to estimate and remit your own tax payments. Technically, anybody who expects to owe at least $1,000 in taxes by the time they file their annual tax return, from sources that are not already subject to withholding taxes, is required to make estimated tax payments throughout the year. Examples of income sources that are not subject to withholding taxes include interest, dividends, and taxable alimony payments.
If you find that you are required to make estimated tax payments, it is very important that you do so. Otherwise, you risk being hit with a large tax bill all at once, after you file your tax return. Most people could not afford paying an entire year’s tax liability at all at once, and being forced to do so could even push them into debt or bankruptcy. To avoid this, the government requires all self-employed people to estimate and remit their tax payments throughout the year. Thankfully, the government provides resources and guidelines to walk you through the process.
How To Make Estimated Tax Payments
The first step in making estimated tax payments is to calculate what you owe. The reason it is an “estimated” tax payment is because you do not know exactly what your tax bill will be by the end of the year. After all, your income could rise or fall during the remainder of the year. For this reason, self-employed people will typically use their previous year’s income as a starting point and then do their best to estimate what their income tax will be based on their current rate of earnings and any credits or deductions that might apply.
For example, if a gig worker typically works 4 hours a day doing deliveries, they might project their income and their tax liability based on that same workload. If later on they decide to work less hours, then they would update their estimate the next time they file.
The schedule of when you file your estimated tax payments is set out by the IRS. For 2022, payments are due as follows:
| When to Make Estimated Tax Payments | |
|---|---|
| Payment Due Date | For Income Earned During… |
| April 18th | January 1st through March 31st |
| June 15th | April 1st through May 31st |
| September 15th | June 1st through August 31st |
| January 17th of next year | September 1st through December 31st |
As you can see, the periods covered are not equal quarters, even though the payments are often referred to as “quarterly payments.” For instance, the period covered by the June 15th payment date is only 2 months long, whereas the period covered by the April 18th payment date is 3 months long. Because of this, it is important to refer to the payment dates from the IRS rather than simply using your own calendar. If the payments happen to fall on a weekend or holiday, then the adjusted payment deadline would be the following business day.
The procedure for actually calculating your taxes is described in Form 1040-ES (“Estimated Tax for Individuals”). As the name implies, this form provides all the necessary information for self-employed people to estimate their taxes, as well as additional information such as the payment deadlines, government support hotlines, and special exemptions. The form also includes a detailed worksheet that self-employed people can use to calculate their taxes line by line while factoring in any applicable income tax deductions or credits.
Typically, this calculation is relatively straightforward as long as you have kept accurate records of your income and expenses, such as by using accounting software. If on the other hand your records are disorganized, it may be necessary to hire an accountant or bookkeeper to help you accurately calculate your income. If this is the case, make sure you plan ahead and give adequate time so that you don’t miss the deadlines.
Once you have determined your income and estimated your tax liability, there are many ways for you to pay. The IRS provides several methods for payment, which are printed on Form 1040-ES. These include paying through your IRS Online Account, paying by cheque, paying over the phone, paying by credit card, or paying through an online banking portal. There is even a mobile application called IRS2Go with its own payment options.
What Happens If You Can’t Afford to Pay the Estimated Amount
Generally speaking, it is a good idea to pay as much as you can, even if you are not able to pay the full amount that you estimate you owe. After all, you want to avoid a situation where you are required to pay a large amount at the end of the year after filing your annual tax return, at a time when you may not have saved enough cash to cover the lump-sum tax bill. By paying as much as you can throughout the year, you will minimize this risk.
If you unfortunately do find yourself struggling to meet your tax payments, it is possible to request support from the IRS in the form of a Payment Plan, an extension to your payment deadline, or even a full or partial forgiveness of your tax owing. Although there is no guarantee that the IRS would agree to these requests, having a history of proactive and consistent payments will make it easier for the IRS to consider doing so.
Special Considerations
In addition to staying on top of your estimated tax payments, there are also other financial commitments that self-employed people should consider planning ahead for. Although individual circumstances will vary, it may be wise to allocate a portion of your income each month to retirement savings, life insurance, or longer-term financial goals such as buying a house or paying for college. In doing so, there are many resources that can be helpful, ranging from free online educational resources to professional financial planners.
How do you calculate estimated taxes?
When calculating your estimated taxes, one common approach is to start by using your previous year’s total tax liability as the baseline, and then adjusting it upward or downward depending on whether your income is increasing or decreasing. Other factors, such as whether you qualify for new tax credits, would also need to be considered. FORM 1040-ES provides a detailed worksheet you can use to walk through all the steps of calculating your estimated taxes. Alternatively, you can also use tax preparation software, or ask for professional assistance.
What happens if my income changes during the year?
If your income changes during the year and you realize that your previous estimates may have been inaccurate, you can simply adjust your estimate accordingly in your next quarterly filing. For instance, if you underreported in the first quarter, you can increase your estimate in the second quarter in order to make up for the initial shortfall. At the end of the day, estimated taxes will always deviate at least somewhat from your actual tax liability, so it is normal for these kinds of adjustments to be made.
Are estimated tax payments only relevant if you are self-employed?
No, you may still need to make estimated tax payments even if you are not self-employed. This can occur in cases where you receive a relatively large portion of your total income from sources that are not subject to withholding taxes, such as dividends or interest income. Form 1040-ES provides full and up-to-date guidelines you can use to determine whether or not you are required to pay estimated taxes.
The Bottom Line
Although there is certainly a learning curve involved, being self-employed can be a deeply rewarding experience, both personally and financially. Developing the right habits when it comes to your taxes and other financial commitments is a great step toward getting the most of what self-employment can offer.
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