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Understanding Quarterly Self-Employment Taxes

If you are self-employed, have a side hustle, or earn investment income that requires you to pay $1,000 or more in federal income taxes, you may need to make quarterly estimated tax payments to the IRS to avoid penalties. This guide will help you understand how quarterly self-employment taxes work, who needs to pay them, and how to make these payments.

How Do Quarterly Self-Employment Taxes Work?

Federal law mandates that income taxes be collected on a “pay as you go” basis, meaning taxpayers must make payments throughout the year as they earn income. Employees typically have taxes withheld from their paychecks by their employers. However, if you are self-employed or receive significant income from investments or other sources, you may need to make quarterly payments toward your federal income taxes.

If your self-employment or other income generates enough to require paying $1,000 or more in taxes, you must submit estimated tax payments to the IRS. These payments are based on the income you expect to earn over the current year. States with income taxes may also require quarterly estimated tax payments.

Calculating Estimated Tax Payments

To determine your quarterly tax payments, you need to:

• Estimate your income for the upcoming year using your previous year’s return as a reference.
• Calculate the taxes applicable to that income amount.
• Subtract any applicable credits or deductions from your tax obligation.
• Divide your estimated tax obligation into four payments.

These calculations can be complex and vary based on your financial situation. IRS Form 1040-ES provides detailed instructions, but you may want to use tax-preparation software or consult a professional advisor for assistance.

Prepayment Schedule Options

The IRS offers two options for dividing your estimated tax obligation into quarterly payments:

• Regular installment payments: Divide your annual estimated tax by four and make equal payments each quarter.
• Annualized income installment payments: Structure payments to match your income flow, paying as little or as much as needed each quarter, as long as the total equals your full estimated tax.

For example, if your business earns most of its income during summer and autumn, you could opt to pay 0% in April and June and 50% each in September and January using annualized income installment payments.

Penalties for Underpayment

If you fail to make quarterly estimated tax payments, are late, or your total annual payments are less than required, the IRS will charge interest on the shortfall. The specific charges depend on the underpayment amount, the duration of underpayment, and the applicable interest rate. For the first and second quarters of 2023, the interest rate is set at 7% for individual taxpayers. IRS Form 2210 provides procedures for calculating interest payments.

Generally, if you make estimated tax payments covering the full amount paid the previous year, the IRS won’t penalize you even if your payments cover less than 90% of your current year’s tax obligation. However, you must pay any remaining amount when you file your tax return.

Who Has to Pay Quarterly Self-Employment Taxes?

For the 2023 tax year, you must pay estimated tax if both of the following are true:

• You expect to owe at least $1,000 in tax for the year after subtracting withholding and refundable credits.
• Your withholding and refundable credits are less than the smaller of:
  • 90% of the tax to be shown on your 2023 tax return, or
  • 100% of the tax shown on your 2022 tax return, assuming it covers 12 full months of income.

How Do You Pay Quarterly Self-Employment Taxes?

You can submit quarterly estimated tax payments in several ways:

• Set up a secure online account at IRS.gov/account to make direct payments from your checking account.
• Use the IRS2Go smartphone app.
• Visit IRS.gov/Payments for options to make one-time direct payments, pay by credit card, or use a digital payment service like PayPal. The site also provides instructions for paying in person, by check, or setting up an installment plan.

The Bottom Line

If you’re self-employed, you likely need to make quarterly estimated payments covering your income tax, Social Security, and Medicare obligations. While the process can be challenging initially, once you establish a system, you can anticipate and set aside funds for these payments. Consider working with a tax professional or using software to help you manage your tax obligations effectively.

For any mortgage-related needs, feel free to call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey with confidence.

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