There’s a pretty prevalent misconception out there that if you make your own way — in your business or as an independent contractor — that you only have to account for your income taxes at the end of the year.
A lot of people also incorrectly think that, if they have a side business in addition to a traditional job — that somehow — their second source of income doesn’t count as self-employment income.
These are erroneous beliefs that you can only have once, before realizing the error of your ways, because you’ll likely soon after get a letter from the IRS saying you owe penalties and interest.
But who wants to make mistakes when you can educate yourself and avoid them? Here are some things you need to know to help you avoid these common pitfalls.
What qualifies as self-employment income?
If you’re an independent contractor or own your own business – whether you do it full time or as a side business – you have self-employment income. The rules of paying your taxes, therefore, are pretty different from your friends with traditional 9 to 5 employers.
In fact, unless you also have a traditional job, you probably have to send the U.S. Treasury a payment four times a year in quarterly payments using quarterly payment vouchers found in the Form 1040-ES Packet, Estimated Tax for Individuals.
If you have a traditional employer, plus a side business
If you’re a traditionally employed by someone else and also receive income from self-employment, you can simply ask your employer to withhold more of your paycheck, so you don’t have to pay quarterly.
Do this by filling out a new Form W-4, Employee’s Withholding Allowance Certificate.
This will take away the burden of making quarterly payments, so take advantage of this option if you can.
If you have strictly self-employment income
Assuming you don’t have the luxury of greater withholding available through your employer, you’ll have to compute your self-employment tax yourself — or with a tax professional — and send in the payments quarterly.
The IRS prefers four equal payments, so in the Form 1040-ES packet, see the Estimated Tax Worksheet. This form helps determine the total estimated amount of tax owed for the year on that self-employment income. Dividing this number by four gives the amount of each quarterly payment owed.
Incidentally, when a person with self-employment income pays taxes quarterly, those payments cover not only income tax, but both sides of the payroll tax, as well. So your Social Security and Medicare contribution is essentially rolled into your income tax calculation.
Furthermore, just as there is an April deadline for the traditional end-of-the-year return, there are deadlines for each quarterly payment. For example, in 2014 these were/are:
- April 15, 2014
- June 16, 2014
- September 15, 2014
- January 15, 2015
There is one flexibility in this seemingly rigid quarterly payment structure, which is that the last payment doesn’t need to be made, if your end-of-the-year return is filed by a certain prescribed date (February 2, 2015 for tax year 2014) with the remaining tax balance amount included in full.
One final note of caution is necessary as pertains to paying quarterly taxes. You probably owe a penalty if you’ve made your quarterly tax payments, but you’ve:
- Paid less than 90% of what you owe in the current year, and
- Paid less than 100% of what you owed in the previous year
In other words, it’s not like you can make up for lost ground at the end if you didn’t pay enough.
Other things to consider
Just to be clear, there are other types of taxes you might have to be subject to – here we’re dealing strictly with the income tax.
Other taxes you might be subject to might include:
- Excise tax
- Sales tax
- Taxes on employees
These taxes are separate considerations that you would have to deal with as well, if they apply.
Get help from a professional to help avoid penalties and interest
If all this self-employment income and quarterly tax payment stuff sounds like a pain, that’s because it is. Remember, Dino Tax Co helps individuals and business with their taxes in the Kingwood and Houston area. We can help you prepare and send in your quarterly payments with no hassle to you and at a fair price to boot.