Working for yourself presents a host of benefits, such as never having to report to a boss and setting your own hours. It also carries a few added tax requirements, such as paying your taxes quarterly instead of with each paycheck as a W-2 employee would.
Keep reading to learn answers to questions like, "Who has to pay quarterly taxes?" "When are quarterly taxes due?" and "How do I pay quarterly taxes?"
Who is required to file quarterly taxes?
If you work as a self-employed individual or small business owner, you likely need to pay quarterly estimated taxes. You're considered self-employed if you work as:
- An independent contractor
- A sole proprietor in a trade or field
- A member of a partnership that conducts business, such as an LLC
- A person who runs a business as your own, including part-time
Who should pay estimated taxes?
The IRS uses a pay-as-you-go income tax system, meaning you must pay your taxes as you earn income. It enforces this by charging penalties for underpayment if you haven't paid enough income taxes through withholding or making quarterly estimated payments. It also charges penalties on late payments even if you get a refund.
The IRS uses a couple of rules to determine if you should make quarterly estimated tax payments:
- You expect to owe more than $1,000 after subtracting withholding and tax credits when filing your return.
- You expect your withholding and tax credits to be less than:
- 90% of your estimated tax liability for the current tax year
- 100% of the previous year's tax liability, assuming it covers all 12 months of the calendar year
The tax code calls this last item the safe harbor rule. This requirement increases to 110% of your adjusted gross income exceeds $150,000 ($75,000, if you're married and file separately).
One exception applies to farmers and fishers who earn at least 66.6% of their income from their trades and so only need to meet an equivalent amount of their tax liability.
Paying your taxes quarterly can also avoid the cash crunch you might face come tax time. Paying in quarterly installments makes paying your bill far easier than one lump sum payment, especially if you've underestimated your taxes due.
What taxes do self-employed people pay?
As a self-employed individual, you file an annual return but usually pay estimated taxes every quarter. Quarterly taxes generally fall into two categories:
- The self-employment tax (Social Security and Medicare)
- Income tax on the profits that your business made and any other income
For example, in the 2021 tax year:
- The self-employment tax rate on net income up to $142,800 for tax year 2021 is 15.3%. That breaks down to 12.4% Social Security tax and 2.9% Medicare tax. As your income increases past this amount, the 2.9% Medicare tax continues but the Social Security portion stops.
- High earners — generally, individuals with incomes of $200,000 and above or married couples with incomes of $250,000 or more — are subject to an additional Medicare tax of 0.9%.
To calculate your taxable income as a business owner:
- Take your expected annual gross income — the total revenue you received — and deduct expenses and any deductions you're eligible for. For example, if your annual revenue came to $100,000 and you had business deductions that total $30,000, your taxable income amounts to $70,000.
- $100,000 - $30,000 = $70,000 taxable income
- The IRS provides a full listing and reference guide for small business owners. IRS Form 1040-ES is a worksheet that takes you through that calculation and helps you determine your taxable income and payments.
- Once you have an estimate for the taxes you'll owe for the year, divide that number by four and submit your quarterly payments by their due dates.
If you have significant changes in income or expenses during the year, that may impact the quarterly taxes you need to pay. For example:
- If your company loses a big customer and your income drops as a result, you can adjust your quarterly payments accordingly.
- If you land a major contract that increases your income, revisit the worksheet to ensure you're paying the appropriate amounts.
What is the qualified business income deduction?
You may have a chance to reduce your self-employment income further by claiming the qualified business income (QBI) deduction. This allows you to reduce your pass-through income from self-employment or owning a small business by up to 20% on your tax return.
You can reduce the net amount of qualified items of income, gains, deductions, and losses tied to your trade or business. This means items like capital gains and losses, dividends, interest income, and other nonbusiness gains and losses don't figure into this calculation.
In general, to claim the QBI deduction, your taxable income must fall below $163,300 for single filers or $326,600 for joint filers in 2020. Tax year 2021 sees the limits rise to $164,900 and $329,800, respectively.
You first must figure out your self-employment or business income using Schedule C and report your adjusted gross income on Form 1040. From there, you can calculate this pass-through deduction.
When are quarterly taxes due for 2021 and 2022?
To avoid an Underpayment of Estimated Tax penalty, be sure to make your payments on time for tax year 2021:
For tax year 2022, the following payment dates apply for avoiding penalties:
How to pay quarterly taxes
Once you've calculated your quarterly payments,
- You can submit them online through the Electronic Federal Tax Payment System.
- You can also pay using paper forms supplied by the IRS.
- When you file your annual tax return, you'll pay the balance of taxes that weren't covered by your quarterly payments.
You have other options as well when you show an overpayment of tax after completing Form 1040 or 1040-SR. You can apply for part or all of your overpayment to go toward your estimated tax for the current tax year rather than be refunded.
Consider this amount when estimating your tax payments for the current tax year. You can treat the overpayment credited toward your estimated taxes as a payment made on the April deadline for the first quarter of the current tax year.
You can use your new total annual income to estimate your quarterly payments for the next tax year. You can also use software like QuickBooks Self-Employed to track your income, expenses, and deductions throughout the year, which will help with estimating your quarterly payments.
TurboTax Self-Employed will ask you simple questions about your life and help you fill out all the right forms. Perfect for independent contractors and small businesses. We’ll search for over 500 tax deductions to get you every dollar you deserve and help you uncover industry-specific deductions.
