How to Pay Taxes When You Are Self-Employed

Being a freelancer, independent contractor, or other business owner means your finances may be a bit different than if you were an employee. One of those differences is how you pay your taxes. While it may seem a little complicated, you should develop a system to take some of the headaches out of your financial life.

Estimated vs. Yearly Taxes

The US tax system works on a pay as you go basis. As you earn money, you pay taxes on it. Then in April, you compare what you paid to what you actually owe in taxes. You either end up paying more or getting a refund.
When you are an employee, your employer sets aside money from your paycheck and sends it to the government on your behalf. These are the taxes that you see taken out of each paycheck. This takes care of the pay as you go aspect of taxes.

But, if you are not an employee, your employer can’t do this. Instead, you have to set that money aside yourself. You do this by paying quarterly estimated taxes. This means you pay a little bit throughout the year based on what you think you will earn. At the end of the year, you settle up on Tax Day like everyone else.

Do I Need to Pay Quarterly Taxes?

Everyone’s tax situation is different. The IRS has a set of guidelines to determine if you need to pay estimated taxes or not. This is because part-time vs full-time work, marriage, and many other factors will make your situation different from someone else. In general, if you expect to owe $1,000 at tax time, you may need to pay estimated taxes.

You should consult a tax professional if you are unsure if you need to pay estimated taxes. They can help analyze your situation and develop a plan.

Budgeting for Taxes

When you get paid, you get all the money, before taxes. So, you need to set aside the money yourself to have it ready to pay later on.

At the beginning of the year, you should estimate the total amount of money you think you’ll earn during the year. You can then use this amount to estimate the amount of taxes you need to pay for the year. This is known as your tax liability. There are a few ways to do this to ensure you don’t end up with a penalty. Once you figure out your total tax liability, you can budget for it throughout the year.

You should note that you may pay more as a business owner than as an employee. This is because employers pay a portion of their employees’ tax liability. Since you are your own employer, you are responsible for this extra tax. It is not uncommon for self-employed people to budget 30% of their total income on taxes.

The easiest way to budget for taxes is to divide your tax liability into 12 months. Each month, you should set aside that month’s tax liability into a separate bank account.

If you pay yourself on a set schedule, divide your tax liability so that at the end of each quarter, you’ll have enough in your tax account. This way you know it’s there when you need to pay.

Here’s an example. If my total estimated tax liability is $2,400 for the year, I can divide this into 12 months. Each month, I need to be depositing $200 into my tax account. If I pay myself bi-monthly, I can transfer $100 each pay period.

Paying Quarterly

Now, every quarter, you will need to pay your estimated taxes. In our example, I need to pay $600 each quarter. If I’ve been setting that money aside each pay period, it will be ready to go when the tax deadline comes.
The quarterly tax deadlines tend to be:

April 15
June 15
September 15
January 15

Weekends and holidays may change them by a day or two.

The IRS makes it very easy to pay your quarterly taxes. You can use their DirectPay or their EFTPS system. Both take your payment quickly and easily online. If you prefer, you can also pay by paper check.

Be sure to check with your state and local tax authorities too. Chances are you also need to pay them quarterly too.

Throughout the Year

Paying your estimated taxes isn’t the only thing you need to do throughout the year. You should also keep careful records of your expenses. As a business owner, you may have some expenses that are deductible. These can be a huge savings. Save your receipts and keep the records to make settling up in April easier.

Yearly Taxes

When Tax Day rolls around in April, you still need to file your full tax return. This will allow you to compare what you paid to what you actually owe. You’ll take your actual income, deductions and credits, and your estimated payments into account now. Just like everyone else, you’ll end up with either a refund or owing a bit.

Paying taxes as a self-employed person may seem a little daunting. But with a little planning, it can be relatively painless. Just be sure to reach out to a trusted tax professional if you need any help.