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I don’t have an employer to withhold money from my paycheck and send it to the IRS. Keep reading to learn the steps I take to pay my taxes.
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If you are an employee in a traditional work relationship, the company that you work for withholds money from each paycheck. This is sent to the IRS to satisfy your tax obligations. If you overpay, as many people do, then you end up getting a refund. If you underpay, you may owe a small amount when you submit your tax returns.
I’m a freelancer, though, so things work differently for me. I don’t have money withdrawn from what I’m paid. Instead, I have to pay my own taxes four times a year, submitting something called “quarterly estimated taxes.” And, like most people, if I underpay, I also need to submit the rest of the funds out of my bank account when I send in my returns. But since my income is irregular, there’s a greater chance this will happen to me.
I don’t want to get hit with a big surprise tax bill and not be able to pay it. To make sure that doesn’t happen, here’s how I budget to cover my obligations to the IRS.
I estimate the taxes that will be due and add a little extra
In order to make sure I have the money I need to pay my taxes, I estimate the amount I will owe each month based on my year-to-date earnings and how much I expect I will be earning in the future.
When you are required to pay quarterly estimated taxes, you can avoid being hit with a penalty for underpaying the IRS if you pay at least 90% of the taxes owed for the current year or you pay either 100% or 110% of the taxes you paid in the prior year (with higher earners having to pay 110%).
I pay the amount required to avoid a penalty with each estimated tax payment, but I also want to make sure I’m saving extra in case I will owe at the tax filing deadline in April because my income has gone up. As a result, I actually calculate monthly what my likely tax bill would be based on the amount I’ve earned so far and expect to earn going forward. This is necessary for me because my income can change a lot from month to month.
Fortunately, there are plenty of calculators online that quickly and easily calculate estimated federal taxes (I don’t owe state taxes because I live in Florida). If you have an irregular income and you want to be sure you’re saving the right amount for your taxes each month, you may want to use one of them — as I do — to get a good idea of what you’ll owe at year’s end.
I transfer the money into a high-yield savings account each month
Once I know how much my tax bill is likely to be based on my current earnings, I simply transfer an appropriate amount into my savings account each month so I can stay on track to pay my taxes.
The money in my savings account is there for me when estimated payments must be made, and also when I file my April returns. By paying 1/12 of my estimated tax bill each month into my savings account, I’m never caught off guard by a big bill to the IRS. The money is essentially taken out of my checks (by me) as I earn it, just like it would be from a typical employee. And I don’t end up scrambling to find the cash when a payment comes due.
If you’re a freelancer and have irregular income, you may want to do the same so you don’t get hit with surprise bills. Figure out how income fluctuations affect what you’ll owe, then be sure to save the right amount as you earn the money so you aren’t caught off guard in the end.
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