Dear Miss Money Matters,
As a freelancer, how much of my income should I put toward estimated tax payments?
– Kate M., Hamden, Conn.
Figuring out how much to pay in estimated taxes can be confusing. I know because I’ve been doing it for years.
Click to read more about how to file taxes if you’re self-employed.
Freelancers and self-employed workers are responsible for making quarterly estimated tax payments to both the federal government and their state government because they don’t have employers who are withholding taxes for them. You might also have to make estimated tax payments if you receive investment income or alimony.
You need to make estimated payments if you expect to owe at least $1,000 in taxes, according to the IRS. Payments typically are due April 15, June 15, September 15 and January 15 — but the due dates can shift slightly depending on what day of the week the 15th falls. If you don’t pay enough estimated taxes during the year, you might be charged a penalty when you file your tax return in the spring.
I use tax software to file my return, and it calculates the estimated payments I need to make based on my previous year’s income. Of course, if I make more or less during the year, I have to adjust my estimated payments. But those tax software estimates are a good place to start.
If this is your first year earning freelance income, your 2017 tax return might be a good place for you to start if you expect to earn about the same as you did the previous year as an employee. You can figure your 2018 estimated taxes based on the total taxes you paid in 2017.
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However, if you’re not sure how much you’ll be making this year, it gets more complicated. For starters, keep in mind that estimated payments are just that — estimates. “It’s never going to be exact,” said Eric Nisall, an accountant whose clients are primarily self-employed workers and small-business owners.
Your quarterly estimated payments will include at least 15.3 percent of your earnings for the self-employment tax, Nisall said. This tax includes 12.4 percent for Social Security and 2.9 percent for Medicare. When you’re employed, your employer pays half of this tax for you. But you have to pay the full 15.3 percent when you’re self-employed.
On top of that, you’ll have to pay state income tax and federal income tax. Check your state department of revenue to find out what your state income tax rate is — or click here to learn more about state income tax rates.
You can find the federal income tax rate schedules on Form 1040-ES. This form also has a worksheet that can help you figure what your federal estimated tax payments should be. These payments should also include the amount you owe for self-employment tax.
Be aware, though, that income ranges for tax brackets are based on annual adjusted gross income — not quarterly income. So the tax rate you pay each quarter isn’t based just on the income you earn in that quarter but rather the total amount you make over a year. “If you look at in a vacuum, you’d be underpaying,” Nisall said.
Ideally, you should set aside money from each check or payment you get into a savings account so you’ll have the cash to make quarterly payments. “I always tell people, if you can get away with it, put away 40 percent to 50 percent at the top,” Nisall said. “At the least, put away 25 percent.”
Then if you find at the end of each quarter that you saved more than you need to pay in taxes, you can hang onto the money.
If you discover that you haven’t paid enough for the first three quarters — perhaps because you ended up earning more freelance income than expected — you can reconcile it with a bigger fourth-quarter payment, Nisall said. To avoid paying a penalty, you need to make estimated tax payments equal to at least 90 percent of what you actually owe for the year.
You also can escape the penalty if you pay 100 percent of the previous year’s tax liability, he said. So if all else fails, divide what you paid in taxes last year into four equal payments.
If you’re worried about paying enough, “The best thing to do is consult a professional,” Nisall said. Sometimes it’s worth it to hire an accountant for your taxes.
Click through to read more about tips and tricks to make sure you pay yourself first.
Life + Money columnist Cameron Huddleston answers your money questions, drawing from her more than 15 years of experience as a personal finance journalist, as well as advice from financial experts. If you have money questions, send them to firstname.lastname@example.org with the subject line Dear Miss Money Matters.