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What are self-employment taxes?

If you are self-employed as a business owner, gig-worker, freelancer, contractor, or run a side-hustle, this article is tailored for you. Explore tax deductions, advantages, and additional tax insights to ensure you maximize your earnings.

Key self-employment advantages:

• Qualified Business Income (QBI): This deduction is a significant benefit that enables self-employed individuals to deduct up to 20% of their QBI before determining income taxes.

• 50% self-employment tax deduction: This deduction permits taxpayers to claim an above-the-line deduction equivalent to 50% of their self-employment tax payments.

• Home office expenses: Exclusive to self-employed individuals, deduction of home office expenses is a valuable benefit. Additional smaller deductions such as insurance, phone bills, supplies, and gifts should not be overlooked as they all contribute to reducing taxable income.

The common goal of these benefits is to lower your tax liability and help you retain more of your hard-earned money.

Who needs to make estimated tax payments?

Estimated tax payments are necessary for individuals who receive taxable income that is not subject to federal income tax withholding. This includes interest, dividends, various types of investment income, and self-employment earnings.

Certain types of income, such as unemployment benefits and retirement income, offer the option of voluntary withholding. In these situations, you can choose to have taxes withheld from your payments or opt to make estimated tax payments instead.

Typically, you are required to make estimated tax payments if you anticipate owing at least $1,000 when filing your taxes, if you are self-employed, or if you engage in a side job during the year. Various types of income may necessitate estimated tax payments, including:

• Self-employment or gig income, such as driving for a ride-share service or delivering groceries or food;

• Investment income, such as interest, dividends, and capital gains from stock transactions;

• Rental income;

• Certain legal settlements;

• Gambling winnings;

• Prizes; and

• Selling a business.

Self-employment income often requires quarterly tax payments. If you are self-employed, you are responsible for making estimated tax payments every quarter to cover your anticipated:

• Income taxes;

• Self-employment taxes, which include both your share and the employer's share of Medicare and Social Security taxes paid to the IRS every payday; and

• Other taxes, such as alternative minimum taxes.

How much do I put aside for taxes in order to avoid liabilities and penalties?

Tax laws mandate that individuals must prepay taxes using one of two methods: through withholdings deducted from paychecks, as employees do, or through estimated tax payments, a practice typically followed by self-employed individuals on the April tax deadline day or on specified quarterly estimated tax days. In April, taxpayers reconcile with the IRS by filing their tax return, settling any taxes owed or balances due, or claiming refunds from the IRS.

Regardless of whether you are an employee or self-employed, it is essential to pay taxes as you earn income. For self-employed individuals, this is typically achieved through making estimated tax payments. Here is a guide on how to do so:

Calculating your quarterly estimated taxes:

Step 1: Estimate your taxes after factoring in deductions and tax credits for the year.

Step 2: Divide the estimated tax amount into four quarterly payments and remit them throughout the year. The IRS has specified dates for these payments, usually the last business day of each quarter.

When are estimated tax payments due?

Refer to the visual breakdown provided below. Due dates that fall on a Saturday, Sunday, or Federal Holiday automatically extend to the following business day.

How to calculate estimated tax payments

To calculate and submit your quarterly estimated tax payments, you utilize IRS Form 1040-ES. You can complete Form 1040-ES manually, use tax software, or opt for Pacioli Finance to file the form on a quarterly basis. The necessity of making quarterly tax payments depends on the anticipated amount of taxes you will owe when filing your tax return.

When determining your estimated tax, you must calculate your expected adjusted gross income, which comprises your total income minus specific deductions, taxable income, income taxes, other taxes, and credits for the year.

When estimating your tax for the current year, you have two options to avoid penalties. You can either pay 100% of the total taxes from your previous year's return, which might result in a higher amount owed, or you can estimate your expected annual income and the corresponding taxes.

If you overestimated your earnings, simply complete another Form 1040-ES worksheet to reassess your estimated tax for the upcoming quarter. It is crucial to estimate your income as accurately as possible to evade penalties. Adjustments must be made for any changes in your personal circumstances and tax laws.

It is important to recognize that failure to pay sufficient tax through withholding and estimated tax payments may result in penalties imposed by the IRS. Additionally, penalties may apply if your estimated tax payments are delayed, even if you are entitled to a refund upon filing your tax return.

Payment options for estimated taxes

You have the option to send estimated tax payments along with Form 1040-ES by mail, or you can make payments through the IRS online platform, via phone, or using the IRS2Go mobile app on your device. Paying online is the most secure method as it ensures immediate processing and acknowledgment of your payment. Additionally, online payments offer quick verification and eliminate concerns about theft from a physical mailbox.

If you choose to make estimated tax payments online, you do not need to file Form 1040-ES. There are various online payment options available to you.

IRS Online Account

Setting up an IRS Online Account provides you with the most flexibility in payment methods. While the initial setup may take 15 minutes to two hours for verification, once established, you can make payments using various methods such as your bank account, credit card, and the Electronic Federal Tax Payment System. Your online account also grants secure access to a range of information including past returns, transcripts, IRS notices, refunds, and more.

IRS Direct Pay

If you prefer not to create an IRS Online Account but still need to make timely estimated tax payments on personal income, IRS Direct Pay offers a quick and account-free payment method. Though it provides more limited access to IRS information compared to an IRS Online Account.

When making online payments using either method, you can choose to pay monthly or per transaction based on your needs. For instance, recurring payments like taxes on investments and rental income can be paid monthly, while less frequent transactions such as estimated taxes for a lump sum amount can be settled at once.

If you send multiple payments before the quarterly deadline, the IRS consolidates them into a single sum for the respective quarter. For example, if you make monthly estimated tax payments for self-employment income in January and February, and a large payment in March for a legal settlement, the IRS will consider your first-quarter taxes as the total sum paid before April 15.

When mailing your payment, the U.S. postmark date is considered the payment date. If an estimated tax payment due date falls on a weekend or holiday, making the payment on the next business day ensures it is considered on time.

Remember to report the payments made using Form 1040-ES on your annual tax return (Form 1040) in the same section as withholdings and refundable credits to avoid double taxation on your income.