The tax system in the US works on a pay-as-you-go basis, so the IRS collects income taxes throughout the year via payroll taxes. Ideally, when you file your tax return, you have already paid all of your taxes by the April deadline. Most people overpay their taxes, which is why they get a tax refund from the IRS. If you underpay, you will face a penalty when you file your return.
As a freelancer, you don’t have an employer to withhold your federal taxes from each paycheck. You shoulder that responsibility on your own by making tax payments each quarter.
Paying quarterly taxes is mandatory if you are self-employed. The following categories fall under the same tax status which is “self-employed”.
Moreover, you need to make estimated tax payments if you owe $1,000 or more in taxes when you file your annual return. The same is the case with corporations that expect to owe at least $500.
On the other hand, you don’t need to make estimated tax payments if all of your earnings are reported on a W-2. Employers who issue a W-2 have withheld taxes for you throughout the year. You also don’t have to pay estimated taxes if you meet the following conditions:
As a freelancer, if you fail to make estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers can avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.
If you don’t pay the amount you owe or if you miss a due date, you will be required to pay a penalty to the IRS. The penalty amount usually depends on how late you paid and how much you underpaid.
There are a couple of ways to ensure you avoid paying penalties:
The general rule for avoiding a penalty is that you must pay at least 90% of your tax liability for the quarter or year. However, there is one exception to this rule. Farmers and fishermen who earn at least two-thirds of their gross income from farming or fishing only need to meet 66 2/3% of their tax liability.
The foolproof way to avoid any penalties is by paying 100% of your tax liability from last year. This is often called the safe harbor rule.
To avoid penalties, it is important to calculate your taxes properly. Here, FlyFin’s quarterly tax calculator can ease your burden by automating your tax payments for every quarter and not just at the end of the year. The app allows you to track expenses and income on an “ongoing” basis, making quarterly taxes very easy and accurate.