As a self-employed taxpayer, understanding when and how to pay your taxes is essential to a successful business. The general rule of thumb is that you should make quarterly tax payments if you will owe at least $1,000 in tax payments. Many businesses fall into this category and therefore it is better to be safe than sorry. The quarterly tax payments are comprised of the self-employment tax, which includes Social Security and Medicare, and income taxes on the profits from your business and any other income you received during the tax year.
Regardless of whether you make quarterly tax payments, you are required to pay your self-employment taxes. For 2019, the self-employment tax rate on net income up to $132,900 is 15.3 percent. This includes a 12.4 percent Social Security tax and a 2.9 percent Medicare tax. If your income exceeds $132,900, then the 2.9 percent Medicare tax does not apply but you will still be taxed 12.4 percent for Social Security. Taxpayers with a net income over $200,000 are subject to an Additional Medicare Tax of 0.9 percent.
On the other hand, if you were an employee, you would have to pay 7.65 percent of your income in Social Security and Medicare taxes and your employer would make an additional tax payment of 7.65 percent to the IRS. This way, the estimated taxes are substantially paid when it is time to file. However, as a self-employed taxpayer you are required to pay both portions, totaling 15.3 percent. It is truly a cost to be the boss.
The IRS also wants self-employed taxpayers to pay their income taxes in quarterly payments. You may be thinking, “Well, I don’t know how much I will earn this year so how can I estimate how much I will have to owe?” It is always a good starting point to use your annual income from the previous year to estimate your quarterly tax payments for the current tax year. Now, the IRS wants your best estimate based on the income you earn and the recent tax rates. Your estimated payments must equal at least 90 percent of your tax liability for the current year or 100 percent of your tax liability from the previous tax year. Failure to do so may result in an estimated tax penalty, so do your best so that your tax bill is substantially paid when it is time to file.
Additionally, Form 1040-ES is a worksheet that will help you compute your taxable income and estimated payments. Once you have your estimated tax payments, divide the estimated amount by four and submit the quarterly payments by their due date. You can mail in your payments or pay online through the Electronic Federal Tax Payment System.
Alternative to Estimated Tax Payments
Taxpayers who work for an employer in addition to their self-employment may be able to increase their federal tax withholding at the job where they are employed in order to cover the taxes on the self-employment income. If you can increase the federal tax withholding, then you may not have to pay estimated tax payments. However, if after the increase you still owe at least $1,000, then you are still required to make the estimated tax payments.
To simplify this process during the tax season it is a good practice to keep your business account and personal account separate. If your business is a separate legal entity, you must separate your business and personal funds.
Aside from the commingling violations that could be associated with your type of business, a separate accounting for your business is essential to ensure you are not missing crucial expenses to deduct as well as making sure you claim all of the income that the business has received.
Additionally, a separate business account will provide ease and confidence if you are ever subjected to an IRS audit. Auditors look closely at small businesses with large business expenses and will audit your bank records with a fine-tooth comb to ensure that your business transactions match your business return. Most importantly, always keep proof of everything you plan to claim, and a separate business account is the best way to do that.
We’ve now made it to the end of our series. Tax season is an important part of the year, but it doesn’t have to be the most complicated. My hope is that the tips above, and those provided in Tax Time Part 1: Master Tax Preparation and Tax Time Part 2: Deductions, provided some helpful information, a greater depth of understanding, and have set you up for success this tax season.