Navigating Quarterly Tax Payments for Self-Employed Individuals

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How Do Quarterly Self-Employment Taxes Work?

If you work for yourself, have a side hustle, or bring in investment income that obligates you to pay $1,000 or more in federal income taxes, you may need to make quarterly estimated tax payments to the IRS to avoid penalties. Here’s an overview of how quarterly income taxes work and who must pay them.

Understanding Quarterly Self-Employment Taxes

Federal law requires income taxes to be collected on a “pay as you go” basis, meaning taxpayers must make payments throughout the year as income is received. Employees typically have taxes withheld from their paychecks by their employers. However, if you are self-employed or receive significant income from investments or other sources, you may need to make quarterly payments toward your federal income taxes.

If your income from self-employment or other sources generates enough to warrant paying $1,000 or more in taxes, you may need to submit estimated tax payments to the IRS. These payments are based on the income you expect to earn over the current year. If your state has an income tax, it may also require quarterly estimated tax payments.

Calculating Estimated Tax Payments

To determine your quarterly tax payments, you need to:

• Estimate your income for the year ahead, using your previous year’s return as a starting point.
• Determine the taxes applicable to that income amount.
• Subtract applicable credits or deductions from your tax obligation.
• Divide your estimated tax obligation into four payments.

These procedures can vary based on your financial situation and income sources. IRS Form 1040-ES provides detailed instructions, but you may want to use tax-prep software or consult a professional advisor for assistance.

Prepayment Schedule Options

The IRS offers two options for dividing your estimated tax obligation into quarterly payments:

• Regular installment payments: Divide your annual estimated tax by four and make equal payments each quarter.
• Annualized income installment payments: Structure quarterly payments to mirror your income flow, paying as little or as much as you like each quarter, as long as your payments add up to your full estimated tax.

For example, if your business earns most of its income during summer and autumn, you could opt to pay 0% of your estimated tax in April and June and 50% each in September and January using annualized income installment payments.

Penalties for Underpayment

If you fail to make quarterly estimated tax payments, are late on those payments, or your total annual payments are less than required, the IRS will charge interest on the shortfall, payable when you submit your annual tax return. The specific charges depend on the amount of your underpayment, the time it went underpaid, and the applicable interest rate during the delinquent quarter(s). Interest rates can change quarterly; for the first and second quarters of 2023, they are set at 7% for individual taxpayers. Procedures for calculating interest payments can be found in IRS Form 2210.

Who Has to Pay Quarterly Self-Employment Taxes?

For tax year 2023, you must pay estimated tax if both of the following are true:

• You expect to owe at least $1,000 in tax for the year, after subtracting your withholding and refundable credits.
• You expect your withholding and refundable credits to be less than the smaller of:
  • 90% of the tax to be shown on your 2023 tax return, or
  • 100% of the tax shown on your 2022 tax return, assuming your 2022 tax return covers 12 full months of income.

How Do You Pay Quarterly Self-Employment Taxes?

You can submit quarterly estimated tax payments in several ways:

• Set up a secure online account at IRS.gov/account to set up direct payments from your checking account.
• Use the IRS2Go smartphone app.
• Visit IRS.gov/Payments for options to make one-time direct payments from checking, via credit card, or using a digital payment service such as PayPal. The site also provides instructions for paying in person, by check, or setting up an installment plan.

The Bottom Line

If you’re self-employed, there’s a good chance you’re required to make quarterly estimated payments that cover your income tax, Social Security, and Medicare obligations. Working out your payment requirements and selecting a payment schedule for the first time can be challenging, but once you’ve established a system, you’ll be able to anticipate quarterly payments and set aside the necessary funds. Because the process can be daunting, it might be wise to work with a tax professional or use software to help you get a system in place for paying taxes as you go.

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