Mary Milner, CPA
Solopreneurs are here to stay. Self-employed quarterly tax payment tips for 2020.
Updated: Feb 24, 2020
As the gig economy rushes full steam ahead, solopreneurs have unwittingly become their own tax advisors and are being forced to navigate their way through complex tax situations without any previous experience. You took a risk to be your own boss, to achieve a better work-life balance, and to be directly responsible for your own success. Now it's time to mitigate that risk, ensure you are tax compliant, and to take advantage of the tax benefits available to you so that you never have to return to the corporate grind.
Trust me, I know firsthand how overwhelming it can be when you start working for yourself. There are so many hats to wear and you'll find yourself in so many new roles... some anticipated, some not.
Luckily, my husband and I were lucky enough to have the tax experience to handle that part for ourselves, but we know so many intelligent, hard-working solopreneurs who have started their own enterprise and tax is simply not their cup of tea.
For many of them, the tax part is the area of their new endeavor causing them the most grief. Many of the clients I've helped made the mistake of ignoring their tax obligations the first year until filing season arrived! Due to under-reporting, they found themselves knee-deep in penalties and interest because they had failed to make quarterly estimated tax payments to the IRS.
In their previous employment, the HR department handled payroll and taxes were withheld throughout the year automatically. Now freelancers, independent contractors, sole proprietors, and small-business owners are all left to compute quarterly tax estimates on their own. They've learned quickly being in business for themselves isn't just about building their brand, delivering their product, or auctioning off their skill set to the highest bidder. It also means they have to try to be a tax accountant... or they have come to recognize their need to hire one.
For those of you who have decided to test the entrepreneurial waters, welcome aboard! It's an exciting time and you don't have to let tax obligations take the wind out of your sails. Below, I've provided a brief overview of estimated tax payments for your business as we begin the 2020 tax season.
Quarterly Estimated Tax Payments
Uncle Sam is still here, and he continues to demand his cut of your money. Quarterly. If you're a freelancer, an independent contractor, a sole proprietor, or an individual involved in a partnership, the IRS considers you to be self-employed and requires you to pay quarterly estimated tax payments.
At least initially, making estimated tax payments may be painful. I assure you, I understand your plight. You're trying to get your new business off of the ground. Cash flow is tight. Profit isn't profit yet. It's money you're turning around to reinvest back into your company. It's earmarked for travel expenses, marketing, or that new software application that will streamline your workflow.
To avoid giving even more of your hard earned money to the IRS, the best course of action here is to take a disciplined approach with your quarterly payments. Failure to do so only increases your tax liability as under-reporting (or failure to report) throughout the year leaves you subject to interest and penalties from the IRS.
DO'S & DON'TS
Typically, those who are self-employed, and expect to owe the IRS a $1,000 or more upon filing, must make scheduled quarterly payments throughout the year to avoid penalties.
DO keep all of the following:
Accurate and current financial records.
Profit and loss statements.
Detailed & timely record of revenue (or incoming cash) so you know the financial status of your business.
All of this information is critical to keeping an accurate, up-to-date picture of where your business is at. They are also the records you'll need for tax purposes.
DO calculate your estimated tax payments.
Easier said than done, right? For those of you who share my affinity for tax code, access IRS form 1040-ES here. This link is a comprehensive 9-page publication from the IRS detailing how to arrive at your estimated tax figures & payments for 2020 as well as how to submit payment. If, however, you'd rather step barefoot on your children's LEGO pieces before studying pages of IRS tax code, then read on, I'll give you a brief Cliffs Notes version!
Generally speaking, the simplest method of calculating quarterly estimated tax is to pay safe harbor estimates by paying in 100% of your prior year tax liability in quarterly payments. Simply take the prior year tax liability (Line 16 on the 2019 Form 1010), divide by 4, and pay that amount each quarter by the scheduled IRS due dates listed below.
For those of you with an Adjusted Gross Income (line 8b AGI on the 2019 Form 1040) of $150,000 or greater, the IRS has decided you shall receive special treatment. They require you to pay 110% of your prior year (2019) tax liability in quarterly payments to ensure compliance using safe harbor estimates.
The alternative for those with an AGI both under and over $150k is to pay 90% of your projected tax liability for tax year 2020. If your current year income has changed substantially from last year (either increased or decreased), then it can be worth the time to calculate quarterly estimates based upon your projected current year income.
To do so, you'll need to have updated financials for your business with your year-to-date net income. You'll then annualize the amount to forecast the yearly net income figure. Next, account for any tax adjustments (like meals, home office deduction, depreciation) that may not already be reflected in your books.
Once you arrive at the projected taxable income for your business, you can better calculate what your estimated tax liability will be (assuming that you accurately reflect personal deductions and tax credits). Using this method, 90% of your projected tax needs to be paid in throughout the year in quarterly estimates, so pay 1/4 of the 90% of your projected tax liability.
You may find this method to be more complex and time-consuming, but taking the time to accurately project your income not only helps reduce under-payment penalties and interest, but it also helps avoid the stress associated with a looming tax bill surprise in April when your return is due.
When you have a small business, cash projections are vital to your success and accurately forecasting tax liabilities is a big part of that. I'll admit, I have clients whose eyes begin to glaze over when we discuss this very topic.
They typically allow me to go on for 2-3 minutes before they stop me mid-sentence and tell me to just "fix it". There's no shame in this. Part of running a successful business is knowing your strengths and weaknesses. Some of you will be more comfortable focusing on what you do well and hiring a trusted tax accountant (that's me!) to handle the rest and that's perfectly okay.
DO adhere to the following schedule when making your estimated quarterly payments :
Payment due April 15 for income received Jan 1 - March 31.
Payment due June 15 for income received April 1 - May 31.
Payment due September 15 for income received June 1 - August 31.
Payment due January 15 for income received September 1 - December 31.
DON'T pay one lump sum at year's end.
I repeat... please don't make the mistake of thinking the IRS will be satisfied with one payment at the end of the year. Failure to make quarterly payments can result in penalties and interest. I've seen self-employed clients do this very thing and then come to me after learning of a tax obligation for the year far greater than they anticipated.
For those clients who have the cash to satisfy the debt, it's typically a minor issue but for those who are cash starved, they're left to either put the debt on their credit card or set up installment agreements with the IRS that can drag on for years. Additionally, installment agreements mean that interest and late payments continue to accrue until the full amount of the liability is satisfied. It's a really fast way to take off luster off of being self-employed.
DON'T make the assumption you can miss a payment, and then just catch up the following quarter.
The IRS is a stickler for deadlines, especially when it comes to payments. If you miss one of the payment dates listed above on the schedule, send it as soon as possible. A late payment, even by a day or two, brings the dreaded "s" word into the equation. Being late leaves you SUBJECT to accruing interest and late penalties. Don't leave yourself open to being on the hook with the IRS... it's worse than owing money to your family!
My sincere hope is that I've provided you with the means to handle your quarterly estimated tax payments, but I also ask you to consider this question... what is the opportunity cost of doing your own tax work?
For some of you, numbers are a breeze. You live for fine print, and you feel comfortable researching the IRS website for the information you need. Others of you, while able to take a can-do approach, will find it cumbersome and tedious to handle your own taxes.
Whichever category you find yourself in, there is an opportunity cost associated with being your own tax adviser. Which part of your business is losing out while you navigate your way through tax situations unfamiliar to you or that you are not genuinely interested in?
Can you make more money in your field of expertise during the time it taxes you to compute 90% of your tax liability for the current year to satisfy your estimated quarterly payments?
My point is that for some, it will be cost effective to hire a qualified, trusted tax accountant with some business savvy to help you maximize your potential while you concentrate on what it is you do best. You can trust that your tax obligations are being met in an accurate and timely manner while devoting what precious time you have left in the day to what puts money in your pocket.
If you've found the information I've provided you to be beneficial and would like to seek me out for further assistance, feel free to check out my website at lemonadetaxservices.com. I developed Lemonade to help solopreneurs like you make the most of their time. In a busy world where everyone makes demands of your time, I love to focus on what I do best... delivering a stress-free tax experience right to your inbox.
Hello! Yes, I am a licensed CPA, but I'm not your CPA and not privy to all the details of your particular situation. Please know the above article serves to provide generalized tax information in an effort to educate. It does not serve as, or take the place of professional advice from a tax professional who is well versed on the details of your particular situation. Please reach out to a trusted accountant before taking any action with your taxes.