Here’s why paying taxes sooner than later actually pays off.
As a freelancer, you may spend your time chasing down client payments and struggling to maintain cash flow. Paying estimated taxes every quarter on your estimated profits for the year may seem like a bridge too far – you don’t feel like you have time to estimate taxes. In fact, many freelancers just say “the heck with it” and skip making estimated tax payments. They catch up by paying the entire amount every year come tax time.
If this is your strategy, you may want to reconsider. According to the IRS, an increasing number of taxpayers face estimated tax penalties for not making their estimated tax payments. The number of people who paid an estimated tax penalty went from 7.2 million in 2010 to 10 million in 2015, an increase of nearly 40 percent. While the penalty amount depends on many factors, you could face fines of several hundred dollars or more.
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1. Educate yourself on the entire estimated tax process with help from IRS resources
To better understand why you have to make estimated tax payments, it’s good to go directly to the source that receives those payments: the Internal Revenue Service (IRS).
The IRS website offers a wealth of information on estimated tax payments, including a detailed description of who must pay estimated tax payments and who is exempt. The IRS website also provides details on estimated tax deadlines and how to calculate these estimations, if you don’t have the help of a tax professional to do this for you.
2. Familiarize yourself with the estimated tax deadlines
Each year, the IRS provides an updated schedule for estimated tax payments. For the 2021 tax year, first-quarter payments are due April 18, 2022; second-quarter payments are due June 15, 2022; third-quarter payments are due September 15, 2022; and fourth-quarter payments are due January 15, 2023.
If the 15th lands on a weekend or a major holiday, then the due date moves to the next weekday after the 15th.
The only time that an estimated tax deadline may be extended is if you are a victim of a federally-declared disaster. However, you should check with the IRS to ensure that an extension is available and learn how far the deadline has been extended.
3. Calculate what you owe for each quarter
To accurately calculate your estimated tax payments, you can use the IRS worksheet or accounting and tax filing software, in addition to getting help from a CPA.
Individuals and freelancers who are sole proprietors can use the worksheet in Form 1040-ES to figure out the estimated tax. You will need to know your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. Using the previous year’s figures for these amounts is a good way to gauge the current year. It’s important to estimate your income as accurately as possible to avoid penalties.
Alternatively, if you use accounting software for your business like QuickBooks Self-Employed, the software will do all these calculations for you based on available financial data. This type of accounting software also enables you to export Schedule C information directly into some tax filing apps and solutions to simplify the process.
The tax software can also calculate the estimated tax for you and even provide you with payment vouchers to print and send to the IRS with your quarterly payments.
If you still feel unsure about calculating your estimated tax payments or already use an accountant or tax professional, then you may want to have them take care of this task for you.
4. Add this expense into your budget to determine how much you need to set aside each month to make the estimated tax payments
Your cash flow may not always be aligned with the due dates for your estimated tax payments, especially the first of the payments that hit when the previous year’s taxes may be due on April 15th.
Like all other business expenses, you need to account for this expenditure in your business budget. And if you don’t have a business budget yet, then this is the time to set it up to ensure you have available funds on hand for the IRS.
Numerous budgeting tools are available as standalone products or as features in small business accounting software. Total up the four payments and divide by 12 to determine how much you’ll need to set aside each month.
5. Put the funds in a separate account to ensure you don’t spend the money
When it comes to saving for estimated tax payments, apply the “out of sight, out of mind” model to your thought process.
Have a separate account where you put the funds for these payments so you don’t inadvertently or impulsively spend it on something else.
6. Adjust your spending habits to come up with the money if you are struggling
As a freelancer, it can be difficult to have the type of cash flow that makes these types of payments easy. Your income tends to look like a rollercoaster, with some months where you are flush and others where work and money have dried up.
If you struggle with saving and maintaining cash flow, you’ll need to be tough with yourself and curb those spending habits. Return to that budget where you should have accounted for every penny to see where you can reduce costs. This will free up the necessary funds for estimated tax payments and save you the burden of additional fees and penalties for missing those deadlines.
7. Reassess your freelancing rates and terms to ensure you can maintain a cash flow that helps pay these estimated taxes on time
Not every shortfall in a business account comes down to poor spending habits. You may need to raise your freelancing rates and get paid more for your expertise and skills. Doing so will not only help make those estimated tax payments, but it also may increase your productivity and motivation.
Make sure to tell your clients in writing about your rate changes so that they’ll know to expect a regular increase in rates each year. Regular increases account for your growth in skills and experience, as well as increased cost of living (which includes those estimated tax payments).
Do you owe a lot to the IRS and fear you won’t get caught up? Get in touch to find the best solution.
Published by Debt.com, LLC