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Jaime Campbell, CPA, MBA, CTT, MCT

 

This article is geared toward freelancers in the United States who are legally organized as a sole proprietorship or a single-member LLC.

 

Introduction

In the United States, freelancers need to pay their income taxes quarterly, based on anticipated profits. It’s a “pay as you go” system. When annual tax time comes around and you prepare your income tax return, you settle up after finding out if you paid too much (and are entitled to a refund) or too little (and need to pay some more).

You need to make these payments both to the IRS and to your state, unless your state does not have income taxes (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming).

What happens if you don’t pay as you go? When you file your tax return, if it turns out that you in fact do owe income tax, you are assessed an “underpayment penalty.”

In order to keep on top of your taxes, you need to know:

  

  • Step 1: What is your company’s income and deductible expenses?
  • Step 2: What is your federal and state income tax bracket?
  • Step 3: Can you pay online?
  • Step 4: What are your state’s “safe harbor” rules?
  • Step 5: Do you have a seasonal business?

  

Step One: What is your company’s income and deductible expenses?

Please note, whatever you pay yourself doesn’t count as an expense. Also, depreciation can get slightly hairy, so consult your tax preparer if you bought a piece of software, equipment, or furniture for $5K or more.

 

Step Two: What is your federal income tax bracket and your state income tax bracket?

A tax bracket is the amount of tax you pay, which is determined by how much you earned. As an example, a single person earning between $37, 451 and $90,750 you must pay 25% of it as income tax to the IRS. You can find all of this information online. Once you estimate your profit for the quarter, you multiply it by the income tax rate and send in the payment.

 

Step Three: Can you can pay online?

You can pay your estimated federal taxes online at https://www.irs.gov/payments. In some states, you can pay your estimated tax online, but in other states, you need to mail in a check with an estimated tax voucher so the government employees receiving your check apply it to your account correctly. It is a huge waste of your time – and a source of anxiety – to get a government notice claiming that you didn’t pay what you know you did, all because they didn’t apply your payment to the right account.

 

Step Four: What are your state’s “safe harbor” rules?

The good news is that in many states, you don’t have to send in the entire amount due. You need to make sure you are sending in the lesser of x% of last year’s tax and y% of this year’s estimated tax. The x and y differ from state to state so if you want to avoid the underpayment penalty but not pay in too much, look them up. The x and y for the IRS are 90% and 100%, but if your Adjusted Gross Income exceeds 75K (150K for married filing jointly) then y=110% .

 

Step Five: The seasonality of your business.

Does your business fluctuate during the course of the year? Perhaps it’s seasonal (e.g. you’re a freelance ski instructor). Or maybe you’re living the dream (e.g. you’re the type to take big projects in the winter and travel the world in the summer).

Either way, then make sure to fill out the Underpayment Penalty worksheet on a quarterly basis and not just annually if you’re going to owe money on your annual tax return. When you show the seasonal fluctuations of taxable income during the year, you will either minimize the penalty or make it disappear.