As a freelancer, you get to be in charge of everything - when you work, where you work, who your clients are, and tax withholding throughout the year! Wait. That last one doesn’t sound so fun. It may not be fun, but it’s important. Taxes are a bit more complicated when you’re a freelancer, and you may have heard about freelancers having to file taxes quarterly instead of just once a year. So which is it? Do you file estimated taxes quarterly, or just end of the year taxes in April? The answer is...both!
Do I have to pay quarter estimated taxes?
When you work for an employer, they automatically withhold some money from each of your paychecks for taxes. Throughout the year, they send this withheld money for you to the IRS. However, as a freelancer, you no longer have someone else doing this for you and you have to do this yourself. If you are an individual, sole proprietor, partner, or S corporation shareholder that expects to owe tax of $1,000 or more when their return is filed (earning more than $5,000 a year will typically put you in this category), you have to file quarterly estimated taxes. What this means is that you not only have to do your end of the year taxes, but you also have to file quarterly estimated taxes 4 times a year. If you don’t pay enough tax, you may be charged a penalty. You may also be charged a penalty if your estimated tax payments are late, even if you are due a refund at year end.
How much do I have to pay?
Quarterly estimated taxes are made up of both income tax (just like normal taxes) AND self-employment, or SE, tax. The SE tax essentially covers two of the line items in paycheck withholding: Social Security tax and Medicare tax. Again, salaried workers are paying those, too, but it’s done automatically. When you're employed, you pay half and your employer is obligated to pay the other half. However, when you are a self-employed freelancer, you are your employer. This means that you have to foot the whole bill yourself, and this is why it's known as the self-employment tax. It works out to a pretty significant percentage: 15.3% of the first $128,400 of income you receive, and 2.9% of anything you earn over this threshold. As an employed taxpayer, you would only have to pay half these amounts.
Since the IRS loves their forms, there’s one specifically for calculating and paying your estimated tax. Form 1040-ES is similar to a lot of other tax forms in that you fill out various fields, subtract and add a few of them up, and come up with your owed tax amount.
Though we recommend going through the form above to calculate the exact amount you should pay, you can also follow this general rule of thumb: pay 25% to 30% of your net income for quarterly estimated taxes. Yes, that sounds like a lot, but remember, you are paying both income tax and self-employment tax.
One important thing to note is that this 25% to 30% is calculated on your net income, not your total (or gross) income. Your net income is your total income minus all of your business expenses (these are often referred to as deductions). As a freelancer, you get to deduct "ordinary and necessary" business expenses from your total income to arrive at your net income (which is what you get taxed on). According to the IRS, an ordinary expense is one that's commonly incurred in your business. Necessary means that it's helpful and appropriate to earning that income. You can find more information about business expenses and deductions here.
How exact do my quarterly estimated payments have to be?
The IRS knows that people who aren't working a traditional W-2 job might have irregular income. So they offer a little leeway and won't punish you if you're a little short (safe harbor amounts).
- If you pay 100% of your tax liability for the previous year via estimated quarterly tax payments, you're safe. If your adjusted gross income for the year is over $150,000 then it's 110%.
- If you pay within 90% of your actual liability for the current year, you're safe.
To recap, they expect you to be close (or over), and won't penalize you if you don't get it exactly right (as long as you are within the amounts described above).
Keep in mind, though, that if you expect your income to be significantly higher than last year, you may want to pay more than the safe harbor amount. Safe harbor amounts will help you avoid underpayment penalties, but you could still end up owing a significant amount to the IRS at tax time.
How can I best plan for quarterly estimated taxes?
For many freelancers, the most challenging part of paying estimated taxes is having the cash available to make the payments when they’re due. Without a strategy, you can easily spend all of your cash paying bills or reinvesting in your business. So once you’ve figured out how much you should pay, you need to select a method for setting those payments aside. Here are a few different ways you can do that:
Make monthly transfers into a savings account
Let’s say you calculated your estimated tax for the year based on the safe harbor amounts and decided you need to pay $20,000 this year, or $5,000 per quarter. That works out to $1,667 per month.
At the end of each month, you transfer $1,667 to your savings account, where it will sit until it’s time to pay your quarterly estimates. Set a reminder on your calendar to do this at the end of each month or automate the transfer through your bank. You can either park this money in your regular savings account or put it in a separate account that you never touch unless you’re paying taxes.
Transfer a percent of each payment you get into a savings account
If your income fluctuates from month to month, it might make more sense to transfer a portion of each payment you collect into savings. For example, if you want to follow the general rule of thumb and set aside 25% - 30% of your income, each time you collect a payment from a client you would transfer 25% - 30% of it into your savings account.
Create an account with Maverick
As described above, manually calculating and withholding your own taxes can be a huge pain in the butt! But don't worry, Maverick can make this a breeze and give you peace of mind. When you have a Maverick account, with every payment you receive, we automatically set aside the right amount for taxes into your special 'tax wallet' (note that you always have access to this money, though we highly recommend not dipping into it). At the end of the quarter you'll be sure you have the right amount for taxes and not have to worry about hefty fines. Not only that, but the process for sending this money to the IRS is also streamlined and made easy!
When are my taxes due?
As you’re probably aware, the IRS really dislikes late payments. Filing late can come with penalties, and the last thing you want to do is pay more money than necessary. With quarterly estimated taxes, you're actually paying for the quarter behind you. Here's how it breaks down:
|Payment Period||Due Date|
|Jan. 1st through March 31st||*April 15 (now July 15)|
|April 1st throught May 31st||*June 15 (now July 15)|
|June 1st through Aug 31st||Sept. 15|
|Sept. 1st through Dec. 31st||Jan. 15 of the following year|
*COVID-19 update: The IRS has postponed the deadlines for the first and second quarter estimated tax payments. Though these payments are normally due on April 15 and June 15 respectively, they are both now due on July 15, 2020.
How can I pay my estimated quarterly taxes?
You can mail your quarterly estimates to the IRS using the vouchers included with Form 1040-ES or pay online. To pay online, freelancers can enroll in EFTPS, the Electronic Federal Tax Payment System. It takes a little time at first to get set up with EFTPS, but you can then make payments by phone or online and have the payment debited directly from your checking account. Another option is IRS Direct Pay. You don't have to register to use Direct Pay, but you'll have to enter in your identifying information each and every time you sign on to make a payment.
Do I also have to pay state and city quarterly estimated taxes?
The information provided above described federal quarterly estimated taxes. Depending on where you live, you may also need to pay quarterly estimated income taxes to your state and city. Each jurisdiction has their own rates, forms and sometimes different due dates, so do some research with the Department of Revenue or work with your tax professional to make sure you’re covering all of your bases.
Note that Maverick takes care of all your quarterly estimated taxes. You can create an account in less than 3 minutes by going <here>.
Do I also have to file my end of the year taxes?
"Wow, this is great!" you say. "I’m paying my taxes throughout the year, which means I’m off the hook when all of you salaried suckers are sweating it out during tax season!" Yeah, about that…Even though you’re paying taxes each quarter, you’re still going to have to fill out and file end of the year taxes. We recommend doing this either with an accountant or using services like TurboTax or CreditKarma.
Note that Maverick connects with these services and can easily export all of the relevant information about quarterly tax payments you already made throughout the year with a couple clicks.