When you're self-employed, you don't have an employer to take money out of each paycheck for tax purposes. However, that doesn't mean you can wait until you file your taxes the following April to pay Uncle Sam. Instead, you're required to make estimated tax payments at least quarterly to avoid owing extra in interest and underpayment penalties. (If you'll owe less than $1,000 for the year, then you're normally off the hook for the estimated payments.)
Taxes to Pay
When you're self-employed, you must account for both income taxes and self-employment taxes. The self-employment taxes take the place of the FICA taxes that employees pay, and are composed of the Social Security tax and the Medicare tax. As of 2014, the Social Security portion is 12.4 percent, but it only applies to the first $117,000 of your net self-employment income, while the Medicare portion is 2.9 percent, but it applies to all of your net self-employment income.
Current Year's Tax Liability
The first way to figure your estimated tax payments is using how much you expect to owe in taxes for the current year. According to IRS Publication 505, you won't owe any extra interest or penalties if your estimated payments total at least 90 percent of what you owe for the year. For example, if your total tax bill for the year is $4,000, Uncle Sam will be expecting four quarterly payments of at least $900 each.
Prior Year Safe Harbor
Of course, when you're self-employed, figuring out how much you're going to owe can be just an educated guess, and not a guess you want to risk interest and penalties on. So, the alternative is to make your estimated payments based on the amount of your tax bill from the prior year. As long as you pay 100 percent of your tax bill from the year before through your quarterly payments (or 110 percent if your adjusted gross income is more than $150,000), you're off the hook for interest and penalties no matter how much more you make. If you end up owing less, you receive the excess back as a tax refund.
Even Payments Generally Required
For most people, the Internal Revenue Service requires that you pay the estimated tax payments in equal installments. For example, if you're expected to pay $3,600 throughout the year, you need to pay $900 each quarter, not $100 for each of the first three quarters and then $3,300 in the last quarter. However, there is one exception: If your business is cyclical, you can make estimated payments each quarter based on the income you actually earn. For example, if you make most of your money in the third quarter, that quarter's payment would be larger and the others would be smaller.
- Jupiterimages/Stockbyte/Getty Images