Most people don’t spend a lot of time during the year thinking about their tax payments because their employer simply withholds those payments from their paychecks. If you’re among the nearly 15 million self-employed people in the United States, however, you will likely have to submit your own estimated tax payments throughout the year. That’s also true if you receive a certain level of income outside of your regular employment. The Pennsylvania Institute of Certified Public Accountants explains how it works and offers tax planning advice.
Who Pays Estimated Taxes?
In most cases, you should pay estimated taxes if you are going to owe $1,000 or more when you file your tax return. There are exceptions. Those who file as a corporation, for example, are subject to estimated taxes if they expect to owe $500 or more. Simply having additional income — from self-employment or other sources — doesn’t mean you have to pay estimated taxes, as long as the money withheld from your regular employee paychecks adds up to at least 90 percent of the tax you’ll owe this year or 100 percent of the tax shown on your return for the prior year, whichever is smaller.
How Much Do You Pay?
This part can be tricky, especially if you’re just starting out as self-employed. The basic idea is to estimate how much you expect to make in the coming year and determine what deductions and credits will apply to calculate your taxable income and figure out how much you likely will owe. It may be helpful to use your prior year’s tax return as a starting point. You must pay estimated taxes quarterly, so be sure to refigure your estimated tax for the next quarter if you determine that you’ve estimated your earnings for the year too high or too low. If you’re not certain how to predict what tax you’ll owe, your CPA can help you come up with a reasonable estimate.
When Do You Pay?
Estimated tax payments are generally due four times a year, on April 15, June 15, and Sept. 15 of the current tax year and January 15 of the following tax year. If you’re in a new business and not yet earning income, you don’t have to start paying estimated taxes until you generate some, even if you believe you’ll be getting income later in the year.
What If You Don’t Pay Enough?
If you fail to pay at least 90 percent of the taxes you ultimately owe for the tax year — or at least 100 percent of the tax you paid last year (110 percent if you’re considered a high-income taxpayer) — you will face a 3 percent underpayment penalty in addition to paying the taxes that are still due. Even if you’re not self-employed and don’t have outside income, you may owe estimated taxes simply because your employer isn’t withholding enough for you. You can fix that easily by raising your withholding.
Get a Handle on Your Finances
If you’re launching a new business or starting out as a freelancer, estimated taxes aren’t the only reason to create a budget. Doing so will also help you manage your income and debt more easily. Proper recordkeeping can also ensure that you have the information you need to make important decisions about your growing business.
Your CPA Can Help
Whether you’re seeking ways to manage or minimize your taxes or you want help with a new or growing business, your local CPA offers the expertise you need. Turn to him or her with all your financial concerns. For more resources, such as PICPA’s free CPA locator tool, visit picpa.org/moneyandlife