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Self-Employed? Calculate Your Quarterly Estimated Income Tax

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Authors Note: This has been updated on Nov 10, 2021 with updated information, links, and resources. 

If you’re an independent contractor, sole proprietorship, partnership or S-corporation, you’re probably required to pay your income tax in four installments throughout the year.

Why? Because you have no employer taking that tax out of every paycheck and sending it to the U.S. Treasury. Yet the government still needs your tax money coming in to cover its ongoing operating expenses. Thus, we have a quarterly estimated tax.

There are a few exceptions to the requirement to pay estimated taxes:

  •       You expect to owe less than $1,000 income tax
  •       Businesses filing as a corporation who expect to owe less than $500 income tax
  •       You did not owe any taxes for the previous tax year and did not have to file a tax return

Why “estimated”? Because you’re paying tax on this year’s earnings before they’ve even happened. 

Next April when you do your annual tax return, you’ll have your real income amount and taxes owed for the year. The quarterly taxes you already paid will be compared to the actual amount owed, and any difference will be resolved by either a refund to you or an additional payment from you.

How to do the calculation for estimated quarterly taxes: 

1. Estimate your adjusted gross income, taxable income, deductions, and credits.

The easiest way to do this is to use the previous year’s figures. This method works best for those whose income stays relatively constant year to year. Simply divide your tax liability for the previous year by 4 to determine what you owe for each quarter. 

For instance, if you paid $12,000 in taxes last year, you can pay $3,000 in quarterly taxes this year ($3,000 x 4 quarters).

However, if your income varies, you might consider making payments based on quarterly earnings. In other words, at the end of each quarter, you’ll annualize your earnings and pay an estimate based on this figure. 

This method is slightly more complex and will require more math, but it can be helpful for individuals who have fluctuating income or changing deductions.

2. Calculate income tax.

For this, you’ll need to find out your tax rate (based on your income), as listed in the IRS’s tax brackets. They change every year, so be sure you’re looking at the current rates. The tax brackets for 2021 are here:

Rate For Single Individuals For Married Individuals Filing Joint Returns For Heads of Households
10% Up to $9,950 Up to $19,900 Up to $14,200
12% $9,951 to $40,525 $19,901 to $81,050 $14,201 to $54,200
22% $40,526 to $86,375 $81,051 to $172,750 $54,201 to $86,350
24% $86,376 to $164,925 $172,751 to $329,850 $86,351 to $164,900
32% $164,926 to $209,425 $329,851 to $418,850 $164,901 to $209,400
35% $209,426 to $523,600 $418,851 to $628,300 $209,401 to $523,600
37% $523,601 or more $628,301 or more $523,601 or more

 

Using the $73,000 taxable income from the example in step 1, it would be subject to a 22% tax rate. That works out to $16,060 tax owed (73,000 x .22 = 16060).

3. Calculate the self-employment tax.

This is a combination of the Social Security and Medicare taxes that would normally be taken out of your paycheck if you were working as an employee. If you earned more than $400 in the year, you are required to pay this tax.

The self-employment tax rate is 15.3% of your net income (12.4% Social Security tax; 2.9% Medicare tax). You might also be subject to an additional 0.9% if your net earnings from self-employment exceed $200,000 (or $250,000 if filing jointly).

Keep in mind that self-employment tax is not the same as income tax. However, like income taxes, you might consider making quarterly estimated payments rather than waiting for your annual tax return in order to eliminate any penalties for late payment.

You can calculate your self-employment tax using IRS Schedule C. To pay this tax, you’ll need an individual taxpayer identification number (ITIN).

You can calculate your self-employment tax as follows:

Step A. Calculate your self-employment taxable income by multiplying the estimated gross income by 92.35%. For example:

$100,000 Estimated gross income

x 0.9235

= $92,350 Self-employment taxable income

Step B. Calculate the tax by multiplying self-employment taxable income by 15.3%. For example:

$92,350 Self-employment taxable income

x 0.153

= $14,129 Self-employment tax

4. Add income tax and self-employment tax.

That’s the total amount of estimated tax you owe for the year. You’ll calculate each of these liabilities based on the methods we’ve shown you above, then simply add them together.

You might be wondering what to do about tax deductions at this point. Unfortunately, the IRS does not permit you to make any deductions on your quarterly tax estimates. Instead, you can expect to make these deductions once you file your annual taxes. 

Assuming your estimated payments were accurate, this can potentially mean that you’ll stand to receive a tax refund, depending on the nature of these deductions, so always hang onto your documentation.

Your total estimated tax can be calculated using the same data from the example above:

$16,060 Estimated income tax

+ $14,129 Estimated self-employment tax

= $30,189 Total tax

5. Calculate your quarterly payment.

Divide the estimated total tax by 4. In our example, $30,189 / 4 = $7,547. That’s the amount of the check the individual in this example will write (or pay online) to the U.S. Treasury each quarter.

For the 2021 tax year, estimated quarterly payments are due:

  • April 15, 2021
  • June 15, 2021
  • September 15, 2021
  • January 18, 2022

There are a few other specific situations to be aware of in order to avoid penalties. For example, you must pay at least 90% of what you owe; and if your income is more than $150,000 per year, then you must pay 110% of last year’s tax.

Additionally, you may be assessed a penalty if you make uneven payments throughout the year. The IRS recommends that taxpayers annualize their income and make equal payments to avoid or at least reduce this penalty.

The IRS can make an exception and waive this penalty if you can demonstrate that you were unable to make these payments due to extenuating circumstances (e.g., a car accident or natural disaster).

The IRS also has specific rules for farmers, fishermen, and certain high-income taxpayers. These situations are covered in IRS Publication 505, which explains how these specific professions are impacted by rules governing the self-employed.

If you have any questions about your estimated quarterly tax or any income tax questions, please feel free to contact your Xendoo tax professional. It’s all part of our service, which sets your mind at rest so you can stay focused on growing your business.

 

Sales Tax on Services by State

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a map of the us

When state legislatures in the United States implemented the first sales tax laws to boost revenues in the 1930s, the American economy depended on the manufacture and sale of physical goods. Typically, early sales tax laws allowed only the taxation of “tangible personal property” (TPP), rather than taxing services.

As the United States has shifted from a manufacturing-based economy to a service-based economy, many states started to impose sales and use tax on services as well.  Many businesses that provide services are still unaware of these statutory changes—some mistakenly believe they don’t have to pay any sales tax at all, even if they’re selling services all over the United States.

Every state is different

This guide is designed to provide an overview of the complexity of sales tax on services by state.

Five U.S. states (New Hampshire, Oregon, Montana, Alaska, and Delaware) do not impose any general, statewide sales tax, whether on goods or services.  Of the 45 states remaining, four (Hawaii, South Dakota, New Mexico, and West Virginia) tax services by default, with exceptions only for services specifically exempted in the law.

This leaves 41 states — and the District of Columbia — where services are not taxed by default, but services enumerated by the state may be taxed.  Every one of these states taxes a different set of services, making it difficult for service businesses to understand which states’ laws require them to file a return, as well as which specific elements of their services are taxable.

Categories of taxable services

No two states tax exactly the same specific services, but the general types of services being taxed can be divided roughly into six categories.

Services to TPP: Many states have started to tax services to tangible personal property at the same rate as sales of TPP. These services typically improve or repair the property. Services to TPP could include anything from carpentry services to car repair.

Services to real property: Improvements to buildings and land fall into this category.  One of the most commonly taxed services in this area is landscaping and lawn service.  Janitorial services also fall into this category.

Business services: Services performed for companies and businesses fall into this category.  Examples include telephone answering services, credit reporting agencies and credit bureaus, and extermination services.

Personal services: Personal services include a range of businesses that provide personal grooming or other types of “self-improvement.”  For example, tanning salons, massages not performed by a licensed massage therapist, and animal grooming services can be considered “personal services.”

Professional services: The least taxed service area, in large part because professional groups have powerful lobbying presences.  Professional services include attorneys, physicians, accountants, and other licensed professionals.

Amusement/Recreation: Admission to recreational events and amusement parks, as well as other types of entertainment.  Some states that tax very few other services, like Utah, still tax admission charges to most sporting and entertainment events.

How to use this chart

Remember that within each category of services, states can still have drastically different regulations.  For instance, both Florida and Iowa are marked as taxing “business services,” even though Iowa taxes a wide range of these services and Florida only taxes security and detective services. Keep in mind that locating your business in another country, such as Puerto Rico, may have tax benefits.

For more details about the specific tax liability of your business in individual states, consult state Departments of Revenue for additional information.

 

 

 

This post is intended to be used for informational purposes only and does not constitute as legal, business, or tax advice. Please consult your attorney, business advisor, or tax advisor with respect to matters referenced in our content. Xendoo assumes no liability for any actions taken in reliance upon the information contained herein.

 

How to Reduce Self-Employment Taxes

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a business owner looking at paper receipts

If you’re like most small business owners, you started out as a sole proprietor. And if you came from being employed by someone else, you were totally shocked the first time you saw on your income tax return what you owe in self-employment tax.

“What is that huge amount?” you asked. You were answered, it’s the Social Security and Medicare taxes that used to be taken out of your paycheck by your employer.

“But I never paid that much before.” That’s because your employer paid 50% of it. Now you’re paying all 100%, because you are both the employer and the employee. Welcome to the wonderful world of the self-employed!

Now for the most important question of all: “How can I get it reduced?” There are several strategies you can use. We’ll talk about them here, starting with the one that can save you thousands of dollars.

Register Your Business as an S Corporation

When you are the owner of an S Corporation, you are classed as an employee of the company, meaning that you personally pay 50% of the employment tax and the company pays the other 50%. (Of course, your company must pay you a regular salary in order to take advantage of this.)

As the owner of the corporation, you’ll still have to pay the entire employment tax on your salary: half through payroll deductions and half through personal income tax. However, you don’t have to pay it on distributions or dividends (earnings and profits) that you transfer from the company to your personal account. That’s why many S corporation owners choose to take the majority of their salary in the form of dividends and put the least amount possible on their paycheck.

In case you’re wondering, you can’t avoid the tax completely by not paying yourself any salary at all. The IRS requires you to pay yourself “reasonable compensation” — basically what you would have to pay someone else to do your job. However, as we’ve seen, there are better ways to take your salary than a simple paycheck.

Registering as an S corporation is simple: just file Form 2553 with the IRS by March 15. There are some qualifications you have to meet; read about them here.

Take More Deductions

Self-employment tax is calculated as a percentage of your income after deductions. So the more deductions you can find, the lower your taxable income — and hence the self-employment tax — will be. Here are some places to look:

  • Business travel (including driving to client’s homes or businesses)
  • Product supplies
  • Office supplies and equipment
  • Internet and phone services
  • Interest paid on business loans and credit cards
  • Business-related education costs
  • Marketing expenses
  • Service professionals such as accountants, lawyers and website developers
  • Home office: a percentage of home repairs, maintenance and improvements

The Tax Cuts & Jobs Act

There’s nothing you have to do for this one, except enjoy the tax break! Beginning with your 2018 tax return (filed in 2019), there’s a new deduction for pass-through business entities such as sole proprietorships, partnerships, LLCs and S corporations. (Pass-through means the business income is reported on your personal income tax.)

Until now, that pass-through income was taxed at standard rates; there were no special treatments as there are for big C corporations. Under the new law, you’ll get a deduction of 20% of qualified business income (QBI).

QBI is defined as income, gain, deduction and loss that are effectively connected with your business. It does not include certain investments, reasonable compensation paid to the owner, or guaranteed payments to a partner or LLC member.

Want to learn more about becoming an S corporation, increasing tax deductions or other ways to reduce your self-employment tax? Please consult your Xendoo tax advisor to find the right solution for your business.

 

This post is intended to be used for informational purposes only and does not constitute as legal, business, or tax advice. Please consult your attorney, business advisor, or tax advisor with respect to matters referenced in our content. Xendoo assumes no liability for any actions taken in reliance upon the information contained herein.

 

Income Tax Q & A: IRS Form 1065 for Partnerships

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an image of the 1065 form

What is Form 1065?

The IRS name for this form is “U.S. Return of Partnership Income.” This is an information return for partnerships to report the income, gains, losses, deductions, credits, etc. of the business.

The partnership itself does not pay tax on its income. Instead, the profits or losses are “passed through” to the partners, who pay tax on it through their individual income tax returns. Each partner must include Form 1065 when they file their income tax return.

Who must file Form 1065?

  • All domestic partnerships, except for the cases listed below.
  • Foreign partnerships that have gross income effectively connected with the conduct of a trade or business within the United States
  • LLCs that are classified for income tax purposes as a partnership.
  • Religious or apostolic organizations exempt from income tax under section 501(d) must report their taxable income, which must be allocated to their members as a dividend, whether distributed or not.

Who doesn’t have to file Form 1065?

  • Spouses who materially participate as the only members of a jointly owned and operated business may elect to be treated as a “Qualified Joint Venture”. Instead of a 1065, they report income and deductions directly on their Form 1040 joint return. (Doing this won’t reduce taxes, but it will give each spouse credit for social security earnings.)
  • Foreign partnerships with U.S. partners that had no effectively connected income and $20,000 or less of U.S. source income during their tax year.
  • Foreign partnerships with no U.S. partners that had no effectively connected income and no U.S. partners during their tax year.
  • Qualifying syndicates, pools, joint ventures or similar organizations may elect under section 761(a) not to be treated as a partnership for federal income tax purposes.
  • Real estate mortgage investment conduits (REMICs). Instead, they must file Form 1066.
  • Certain publicly traded partnerships treated as corporations under section 7704. Instead, they must file Form 1120.

When must Form 1065 be filed?

For calendar year domestic partnerships, the due date is March 15, 2019.

If you use a different tax year, the deadline is the 15th day of the 3rd month following the date your tax year ended. If that day happens to be a Saturday, Sunday or legal holiday, file by the next regular business day.

Can I get an extension?

Yes. Use IRS Form 7004 to request an extension of the filing deadline. It can be submitted electronically.

Where can I get a Form 1065?

Your tax preparer can take care of all that for you.

Or you can download Form 1065 and the other forms and publications you may need at irs.gov/forms-instructions. Order paper forms to be mailed to you at irs.gov/forms-pubs/order-products.

Who signs Form 1065?

It can be signed by any partner or LLC member.

If the return is prepared by a receiver, trustee, or assignee, the fiduciary must sign the return. In this case, Form 1065 must be accompanied by a copy of the order or instructions of the court authorizing the signing of the return or form.

How do I file Form 1065?

Postal mail: Send it to the IRS address listed in the Form 1065 instructions. The address varies according to the state your business is located in and the amount of its total assets.

Electronic filing:

  • Most partnerships may choose to do so. See www.irs.gov/ pub/irs-irbs/irb12-10.pdf for how to submit a substitute Schedule K-1 in electronic format.
  • Certain partnerships with more than 100 partners are required to file electronically.
  • Certain types of returns may NOT be filed electronically, including bankruptcy returns and returns with pre-computed penalty and interest.

Private delivery service: The ITS authorizes the use of certain services, including DHL, FedEx, and UPS, to meet the “timely mailing as timely filing/paying” rule for tax returns. Go to IRS.gov/PDS for the current list of designated services. You must use an IRS mailing address, as listed in IRS.gov/PDSStreetAddresses, not a P.O. Box address. Be sure to get written proof of the mail date from your delivery service.

This brief overview does not cover all the complexities of filing Form 1065. For expert advice, please consult your Xendoo tax expert.

 

 

This post is intended to be used for informational purposes only and does not constitute as legal, business, or tax advice. Please consult your attorney, business advisor, or tax advisor with respect to matters referenced in our content. Xendoo assumes no liability for any actions taken in reliance upon the information contained herein.

 

Income Tax Q & A: IRS Form 1099-Misc for Independent Contractors

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What is Form 1099-Misc? This is the form that a business fills out for any freelancers or independent contractors that it hired. Copies of the form are sent to both the IRS and the contractor.

Who must file Form 1099-Misc?

If you paid freelancers or independent contractors a total of $600 or more during your tax year, you must report their income on Form 1099-Misc.

That payment could be in the form of cash, rent, exchange of services, prizes and awards, and just about anything else that has a monetary value.

What is the definition of an independent contractor?

Any individual or unincorporated business who is not directly in your employ, but rather hired on a contract basis to perform work, fits this definition. Unlike an employee, they are completely free to arrange their financial and work-life as they choose.

As the “gig economy” continues to grow, the IRS is looking more closely at businesses that misclassify an employee as an independent contractor in order to avoid tax liabilities and other employment costs. The penalties can be hefty, so if you’re in doubt, consult your tax professional.

Who doesn’t get a Form 1099-Misc?

Independent contractors hired through a third-party service may not need a 1099 if they are considered employees of the service. For example, freelancers hired through Upwork are employees of Upwork. Upwork pays them, and you pay Upwork for their services. Make sure you understand the tax filing status of each service you use before you get into a contract.
Payments to C-corporations and S-corporations are not reported on Form 1099.

When must Form 1099-Misc be filed?

Copy A to the IRS by January 31, 2020, either by mailing a physical copy or sending it electronically, if you are reporting payments in box 7.

If income is reported in any other box, mail Copy A by February 28, 2020, or file electronically by March 31, 2020.

Copy B to the independent contractor by February 15, 2019. You can mail a physical copy or send it electronically; but if you choose the latter, you must have the contractor’s consent and a verified method of transfer, such as an email address.

If income is reported in any other box, mail Copy B by February 18, 2020.

Can I get an extension?

No.

Where can I get a Form 1099-Misc?

Your tax preparer can take care of all that for you.

Or you can get the forms from the IRS website. Instructions are at irs.gov/pub/irs-pdf/i1099msc.pdf.

If you will be filing Copy A (IRS copy) by mail, you must order it to be mailed to you at irs.gov.  DON’T download it from any website including the IRS site; it needs to be a scannable, physical document.

Copy B (contractor copy) can be either downloaded as a fillable PDF form on the irs.gov site.

What information do I need to fill out Form 1099-Misc?

  • Contractor’s legal name
  • Contractor’s address
  • Contractor’s taxpayer identification number (or social security number if they are a sole proprietor)
  • Account number if you have multiple accounts for a recipient for whom you are filing more than one Form 1099-MISC

How do I file Form 1099-Misc?

Postal mail: Send Copy A to the IRS and Copy B to the independent contractor.

Electronic filing: For information about submitting Copy A to the IRS, visit irs.gov/FIRE. For emailing Copy B to the contractor, use a service such as tax1099.com.

What else do I need?

For postal mail filing: Complete and submit Form 1096 (used for paperwork tracking) to the IRS by January 31, 2019. For electronic filing, this step is not necessary.

For the electronic filing: You need a Transmitter Control Code (TCC). Complete Form 4419 and mail or fax it to the IRS at least 30 days before the deadline for submitting Form 1099-Misc.

This brief overview does not cover all the complexities of filing Form 1099-Misc. For expert advice, please consult your Xendoo tax expert.

 

 

This post is intended to be used for informational purposes only and does not constitute as legal, business, or tax advice. Please consult your attorney, business advisor, or tax advisor with respect to matters referenced in our content. Xendoo assumes no liability for any actions taken in reliance upon the information contained herein.