Many people start freelancing or working for themselves without fully understanding their tax obligation and filing quarterly taxes.
If you've considered freelancing in the last few months, you're not alone. In 2017, 57.3 million people freelanced in some capacity in the US, and freelancers are going to become the majority of the workforce in the next 10 years, according to a study from The Freelancers Union. Before you join the rising tide of the self-employed, it's important that you understand what freelancing means for your money and your tax burden. There's a lot of articles on the internet that encourage people to jump into freelancing for the income boost, but what do you know about quarterly taxes?
What Are Quarterly Taxes and Why Do They Matter?
Self-employed people operate on a different tax schedule than W2 employees. The government sees freelancers as both the employer and the employee of their business, while people who hold "regular" jobs are counted as just employees.
As a W2 employee, each time you get a paycheck, your employer takes out a portion of your earnings for taxes. This shows up on your check as things like Social Security or Medicare. Since this happens automatically on each paycheck, the government gets a steady stream of income from you automatically, and you only need to file once a year in April.
CPA Chad Harrison explains that freelance paychecks don't work that way. "Freelancers have no one withholding tax for them. [Freelancers] are paying their taxes throughout the year. The government requires this for two reasons: 1. They have bills they need to pay throughout the year. 2. It's typically easier to collect $250 four different times than it is to collect $1,000 once."
So it falls on the freelancer to separate out their profit from what they owe in tax, and pay them on their own. That means, once a quarter, (on dates set each year by the IRS), they send in an estimation of their annual tax burden.
Anyone who expects to owe at least $1,000 over the course of a year needs to pay quarterly taxes. This applies no matter if you're a sole proprietor, an LLC (single or multiple member) or an S corporation.
Does It Really Matter If I Pay These Or Not?
In a word? YES. Firstly, it's illegal to skip out on your tax payment. Since freelancers don't have anyone else to pay on their behalf, those who skip out on them are breaking the law.
Secondly, paying quarterly can actually be a boon to freelancers. In 2009, a spokesperson for the IRS estimated that about 8.2 million Americans owed back taxes (overdue tax payments), penalties, and unpaid interest.
We're a country that has a hard time saving, and especially with coughing up a big check one time per year. If you waited until April of the following year to file, there's a good chance you'd owe a large amount of money you didn't have in your bank accounts.
Paying quarterly allows you to make smaller payments throughout the year, lessening the burden at any one time. Remember that self-employment tax freelancers have to pay? It comes to 15.3% of the first $128,400 of income you earn in 2018. If you earn above that, you'll pay 2.9% on the rest of your earnings.
Not paying quarterly will definitely mean you'll get hit with some fees, and it could even lead to being arrested for tax evasion.
How to Make Sure You Set Up Your Quarterly Taxes Correctly
The first thing anyone new to self-employment should do is open a savings account and name it "Tax Payments". Now you've got a place to stash your savings until you pay in each quarter.
Next, start saving money from each paycheck you earn. Aim for 25-30% of each check. Harrison says "The concept is that if you pull 30% of your gross income, by the time you factor in any tax deductions that you may have to offset that gross income, the 30% will be more than enough to cover the taxes on your income."
It'll feel like a lot, but keep in mind that you'll be able to deduct business expenses when you file. You can also find out your expected deductions using a formula from the IRS on Form 1040-ES. Remember, too, that the Tax Cuts and Jobs Act passed by Congress in 2017 changed the laws around self-employed tax obligation.
"There's the possibility for middle class freelancers to qualify for the 199A deduction which is a 20% of profit deduction to the income," says Harrison. This change in qualification, plus your deductions, can really impact how much your tax obligation ends up being. It's best to save that 30%, but understand you might not end up paying that much.
The payment due dates vary slightly each year, so always check the IRS website to know when the exact payment is. The months are always the same though, so expect to pay in April, June, September and January of the following year.
Harrison has some advice for any newly self-employed people out there: get organized to avoid penalties.
"A freelancer, especially with the new TCJA bill that passed, should speak to their CPA and make sure they are paying in enough estimated taxes to avoid penalties. To track their expenses, an Excel spreadsheet will suffice, but the best practice would be a cheap and easy software that integrates with your checking account such as QuickBooks Online," says Harrison. Keeping accurate records goes a long way towards avoiding tax problems.
You can even pay early if you want. If you experience particularly intense ups and downs in your income, you can absolutely pay early during a good month.
With preparation and a system for saving, quarterly taxes can be easily handled by any beginning freelancer.