How to Estimate Your Tax Returns as an Independent Contractor
Estimating your tax returns as an independent contractor is an important part of financial business management. If your net-earnings from self-employment are more than $400, you likely need to file an annual return and pay estimated taxes quarterly.
Filing your annual tax return is pretty straightforward. Use Schedule C—this is where you will report your income or loss from your business. Then, you will file Schedule SE (Form 1040 or 1040-SR), Self-Employment Tax to report your Social Security and Medicare taxes.
Quarterly taxes are a bit of a different story. They are generally due on April 15, June 15, September 15, and January 15 of each year. These payments are based on how much income you think you’ll make in the following year. Estimate the amount of taxes you’ll owe based on this income, and divide by four to pay that amount each quarter.
Remember, when you get paid for jobs throughout the year, no taxes are taken out. Even though it might seem like a hassle, paying taxes quarterly helps prevent you from paying a massive tax burden at the end of the year. However, as an independent business owner, you ‘re probably well aware of how much workflow can change during the year. So, how do you know if you’re estimating too much or too little? Here are five quarterly tax tips to help you make the best estimate.
Five Quarterly Tax Tips
1. Follow the Safe Harbor Rule
You can satisfy the “safe-harbor” requirement and avoid any underpayment penalties by paying 100% of the taxes you paid last year. Simply check what you paid last year in taxes and divide that number by four. Then, send that amount in for your quarterly payments.
The one exception to this rule is if your adjusted gross income was over $150,000, you should pay 110% of last year’s taxes. If you feel like your business has been relatively stable, these numbers should be too. You might slightly under- or overpay with this method, but it is a pretty good failsafe overall.
2. Set Aside 30%
Another method many independent contractors follow is simply setting aside 30% of their gross income. When it comes time for each quarterly tax payment, pay that 30%. With this method, your quarterly payments may fluctuate based on the amount of business you conducted in the previous months, and you may slightly overpay. But, that just means a tax refund is in your future.
3. Pay (Almost) Exactly What You Owe
If you want to get into the nitty gritty, you can calculate exactly what you owe each quarter. This can be a useful method if your income varies. You can use Form 1040-ES from the IRS to calculate estimated tax. You’ll need to know your expected adjusted gross income, taxable income, taxes, deductions, and credits for this method. If you’re unsure of these numbers, take a look at your returns from last year as a guide. This method requires a bit more work on your end, and still may not be perfect since you will have to make some estimates.
4. Don’t Forget About State Taxes
If you live in a state that has income tax, you will also need to make estimated tax payments to your state. You can find information about your individual state’s deadlines, resources, and forms through the Small Business Administration (SBA). These payments tend to be a little easier to calculate than federal quarterly payments.
5. Call in the Pros
If you’re new or fairly new to self-employment, getting a handle on taxes can be tricky. In addition to paying your taxes correctly and on time, there’s also a lot of important deductions you may be eligible for. And, in order to do both of these things correctly, it will be essential to keep records of expenses and income up-to-date. If you’re not up for doing this all yourself, or just need a bit of advice and guidance, find a professional tax preparer to consult or a service like MBO to help you navigate relevant forms and always and make sure you claim all of your eligible deductions.
Read next: Filing Independent Contractor Taxes: 4 Best Practices
The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.
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