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Do I Need to Pay Estimated Tax to the IRS?

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If you receive non-wage income, you may need to pay estimated taxes each quarter. Learn who must pay and how payments are calculated. 

Key takeaways

  • Estimated quarterly taxes are paid by workers who are not standard W-2 employees
  • Taxpayers who run their own business or work as an independent contractor need to pay estimated tax
  • Payments are due April 15, June 15, September 15, and January 15
  • Note the self-employment tax, which is a 15.3% tax that comprises Social Security and Medicare 
  • A tax professional can help you calculate what you owe in estimated tax

Running your own business brings lots of perks, including more flexibility and control over what you do. But there are tax implications that you need to be aware of if you are a freelancer or running a sole proprietorship, S-Corp, or another entity.

Many business owners and contractors must pay quarterly taxes throughout the year, known as estimated tax payments. Here is your guide to what these payments are, what kind of business structures need to pay them, and how to do it. We’ll also briefly discuss what the self-employment tax is.

What is estimated tax?

If you are a qualifying entity, you need to pay an estimated quarterly tax if you owe more than $1,000 each year when filing your tax return or have a qualifying corporation and owe more than $500 when filing. These are the payment due dates for each quarter: April 15, June 15, September 15, and January 15.

Because business owners and sole proprietors do not have an employer withholding tax from each paycheck, regular tax payments must be made throughout the year to make up for it. Aside from the income tax obligation, estimated taxes cover self-employment tax and alternative minimum tax. 

Next, let’s talk about who has to make these payments.

Who must pay quarterly estimated tax?

The IRS states that if you are “in business for yourself,” you will usually have to make estimated tax payments. This includes independent contractors, freelancers, and taxpayers with side gigs. These types of businesses must also pay estimated tax:

  • Sole proprietors
  • Partners
  • S corporation shareholders
  • Some corporations

If you are a regular W-2 employee, you probably do not have to pay estimated taxes unless you earn money on the side. If you are one of the above entities and earn a salary or regular wage, you may be able to have your employer withhold more tax from your wages to avoid having to make quarterly tax payments.

You also don’t have to pay estimated tax if you had zero tax liability the year before, were a U.S. citizen for the entire year, and the prior tax year covered a complete 12-month period.

How do you pay estimated tax?

If you have to pay, you can figure out how much you owe by using Form 1040-ES. You’ll need to determine your estimated adjusted gross income, taxable income, deductions, credits, and taxes for the entire year. Try taking a look at your tax information from last year if your situation is similar. Alter how much tax you expect to pay by figuring out how much you will likely earn this year, whether it’s more or less. You then divide what you expect to owe in taxes for the year by four and pay that amount per quarter.

Form 1040-ES walks you through how to figure your estimated tax for each quarter. You will enter information about: 

  • Adjusted gross income
  • Credits
  • Self-employment tax
  • Other taxes

Follow the prompts and instructions on the form to calculate the exact numbers. Then take a look at the applicable year’s tax rate schedules to determine your tax bracket.

You can pay estimated taxes using one of the following methods:

  • Paying online, via IRS Direct Pay or the IRS2Go mobile app, using a credit or debit card, electronic fund withdrawal, or Online Payment Agreement (if you cannot pay in full by the due date)
  • Paying by phone
  • Paying by cash, in person
  • Paying by check or money order using your estimated tax payment voucher

Usually, the fastest and easiest way to pay is via IRS Direct Pay, which can be found at IRS.gov/payments, or on the IRS2Go mobile app. On the IRS payments page, you will select whether you want to pay by bank account transfer or card, choose “Make a Payment” on the next page, and choose your reason for payment as “Estimated Tax.” Make sure you pay by the deadlines each quarter.

What is the self-employment tax?

Part of estimated quarterly taxes is figuring the self-employment tax you owe. The self-employment tax rate is 15.3%, which covers two types of tax: Social Security (12.4%) and Medicare (2.9%).

Because self-employed individuals do not make these contributions from their paychecks, this additional tax is included when making estimated tax payments. And they must pay the full 15.3%, whereas W-2 employers typically cover half of it. This tax is paid on top of income tax and does not replace it. 

To find out your self-employment tax obligation, subtract your business expenses from your gross self-employment income. Typically, 92.35% of self-employment earnings are subject to the self-employment tax, so multiply those earnings by the 15.3% rate. 

In 2020, the first $137,700 of earnings was subject to the Social Security tax; it is $142,800 in 2021. If you earned over $200,000 from self-employment, you might also owe an additional 0.9% Medicare tax.

Talk to a tax professional if you have questions

If you earn income from running your own business or working as an independent contractor, you will probably need to pay quarterly estimated tax payments each year. When you are unsure about your obligations or whether your work qualifies, talk to a tax expert who will make sure you file everything correctly. 

The Provident CPA and Business Advisors team can guide you through tax planning and help you figure out precisely what you need to pay in estimated taxes each quarter. We will help you file your annual tax return and ensure you take advantage of any credits and deductions for which you qualify.

Contact Provident CPA and Business Advisors to get started.

Tax 101 for Gig Economy Entrepreneurs

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Remote and “gig” work are on the rise, and that means there are new tax considerations for this new sector of the workforce

Many workers across the nation are taking advantage of the rising gig economy—whether taking on side jobs to earn extra income, like driving for Uber on the weekends, or freelancing full-time. Some estimates show that around a third of the workforce is taking part in the gig economy, and that number may continue to increase, as workers want better work/life balance, flexible work arrangements, and the potential for higher overall income.

With this surge in self-employment, taxes have become confusing for workers, especially after the Tax Cuts and Jobs Act (TCJA) made some significant changes.

Here are important tax considerations and recent changes for gig economy workers to keep in mind.

1099 forms

First, 1099 forms are likely the most common tax document that a self-employed worker will see. Usually, a company will send a 1099-MISC to freelancers with all income reported above $600. Or, a 1099-K may be sent from third-party providers if a worker had more than 200 transactions and earned at least $20,000. The 1099-K form is meant to report payments that a business receives from credit or debit cards or processors such as PayPal.

However, these forms can create confusion for freelancers, as some clients may not provide them. Gig economy workers should be aware that they need to report all income, even if they made below these thresholds and/or didn’t receive the forms.

Self-employment taxes

Another important tax item to be aware of is the self-employment tax. This is a 15.3 percent tax in addition to income tax. The reason this extra tax exists is so that self-employed workers can pay Social Security and Medicare taxes that would normally be taken out by a traditional employer.

Even though this may seem like a pretty high tax, freelancers can deduct half of it to offset income.

Qualified business income pass-through deduction

The TCJA added a qualified business income deduction of 20 percent, which means that certain businesses could owe less tax. This deduction applies to the following entities, with certain qualifying factors:

  • Sole proprietorships
  • Partnerships
  • S-corporations
  • Some estates and trusts

This is a pass-through deduction that intends to provide help to smaller businesses, as the income limit is $157,500 per year or $315,000 for joint filers. Gig economy workers who are incorporated in certain ways may be able to take advantage of this deduction, in addition to their other qualifying business expenses. Consult with a qualified tax advisor to determine if and how you may be eligible.

Quarterly taxes

Another important part of paying taxes as a freelancer or gig economy worker is the fact that quarterly taxes are often now due. These are estimated tax payments due four times per year, and if freelancers fail to pay them, they’ll could have to pay tax penalties at the end of the year.

This requirement is due to the fact that taxes aren’t automatically withheld from freelance income, as with a traditional employer. Note, however, that gig economy workers who have a main salary that does have taxes withheld may not need to make quarterly estimated tax payments—though it’s advisable to avoid a potentially surprising, large tax bill on the freelance income when April rolls around.

Business equipment deduction

The TCJA increased the deduction amount for business equipment. Now, up to $1 million can be deducted in equipment purchases, including computers, furniture, software, and more. However, actual business income will determine how much can be deducted and freelancers must carefully adhere to qualifying categories of equipment.

Other deductions for gig economy workers

The TCJA cut some deductions, including those for meals and entertainment. This means that some client expenses, such as a dinner meeting, won’t be able to be fully deducted. However, 50 percent of meals still may be eligible, so long as they were directly related to the business.

Other deductions that gig economy workers are eligible for include the home office deduction and the health insurance deduction (if they pay for their own insurance). Many other expenses related to running a business, such as a vehicle, a professional subscription, exchange rate fees, and more, may be deductible, so workers should keep track of all these expenses.

It’s important for those already in the gig economy and those considering entering it to understand these tax issues. Taxes need to be handled carefully so that all income is reported correctly and expenses are accurate.

Gig economy workers need to remember that:

  • Income must be reported regardless of whether a client sends a 1099 form
  • Self-employment tax is in addition to income tax
  • Freelancers may be eligible for the qualified business income deduction of 20 percent
  • Quarterly estimated taxes should be paid to avoid penalties or a surprising yearly payment
  • The TCJA increased the business equipment deduction
  • Meals and entertainment are no longer fully deductible

To discuss tax guidelines with a professional, contact Provident CPA & Business Advisors. We provide tax planning and business consulting services to help you navigate requirements while growing your business.