Estimated Taxes for Freelancers, part 2

Thanks for coming back for part 2 of our FAQ on paying estimated taxes if you’re a freelancer. You can read part 1 here, where we covered what estimated taxes are and whether or not you have to pay them. Let’s continue with some more information about estimated taxes.

Image via sxc.hu.

When do I pay estimated taxes?

You probably know that taxes for each year are due the following April 15. Estimated taxes are paid during the year, however. You’ll pay them quarterly by April 15, June 15, and September 15, of that year and January 15 of the following year for your fourth quarter.

Note – you need to pay TWO things on April 15 every year if you’re a freelancer – you have to clear up any unpaid taxes from the previous year and you have to make your first estimated payments of this year! You can’t combine them and send them in together – they go to two separate places.

How much should I pay in estimated taxes?

That depends on where you live and how much you earn. You’ll have to pay federal, state, and local taxes…and state/local changes depending on where you live. The federal tax rate is calculated by bracket. It’s kind of confusing, and the amounts vary every year, but let’s talk about it from a 2008 standpoint.

For the first $8,025 you made, you’ll pay 10% in federal taxes. The next tax bracket in 2008 was $32,550. So, for your earnings between $8,025 and $32,550, you’ll pay 15%. The next tax bracket in 2008 was 65,725, so for your earnings between $32,550 and 65,725, you’ll pay 25%….and so on. For reference, if you made $100,000, you would have owed about 22% in total, when the brackets are averaged.

That can make it REALLY hard to estimate, right? Money Chimp is a really great resource for estimating your taxes, but remember – most people don’t actually have to estimate at all. Your estimated taxes only need to be 100% of what you paid last year (see part one for an explanation on the prior year safe harbor rule).

If you’re going to be making a lot less (and will, therefore, owe a lot less), you may want to try to estimate instead so you don’t overpay by thousands of dollars. If you’ll be making a lot more (and will, therefore, owe a lot more), it makes sense to pay in a little more than 100% of last year, or you’ll be stuck with a huge lump sum payment at the end of the year.

Officially, if you don’t pay 100% of last year’s taxes, you need to pay in AT LEAST 90% of the amount you’ll owe this year. Otherwise, you could be penalized.

What about social security?

Ah yes, another calculation you have to make. When you work somewhere, your employer takes out money for social security and medicare. You have to pay that yourself – its called the self-employment tax. And it stinks. In a situation where you’re someone’s employee, they pay half and you pay half, but as a freelancer, you pay it ALL yourself. I know. Yuck.

What happens if I don’t pay estimated taxes?

If you don’t pay your taxes at all, you’re going to have a lot of legal problems on your hands…but what if you don’t pay your estimated? Can you just pay it all at once by April 15 and forget all the silly quarterly payments?

Well, you can…but be prepared for penalties. Penalties have been hard to estimate, but are based on you paying at least 90%. If you own $10,000 in taxes in total and paid $8,000, you’ll only be charged interest on $1,000 (the amount needed to reach 90%). At the end of the year, you can fill out a form and the IRS will calculate your penalty for you. It’s based on what you would have owed for each quarter, based on what you paid each quarter, or the late date that you paid the full amounts…like I said, confusing. It’s usually just easier to let the IRS send you a bill (but yes, it stinks having to ASK for it!).

There is one special case that you need to know about – if your income came late in the year. The whole point of estimates is to pay taxes for what you earned each quarter. If you earned just $20,000 Jan through November, and then suddenly doubled your income and earned another $20,000 in December alone, it isn’t fair that you would have to pay for that amount back in the first quarter! If this is the case, you’ll want to fill out Form 2210.

That’s a lot of information to take in, so I’ll have one final post – part 3 – on estimated taxes on Wednesday! It will cover:

• What forms do I need?
• Where do I send the check/forms?
• Can/should I pay early if possible?
• Do I have to pay taxes if am just doing this as a hobby?
• Should I hire an accountant?

Make sure you read part 1 as well!