If you are an independent contractor, it’s always best to be prepared and know how to calculate your estimated tax penalty. You may opt to overpay, but that won’t be necessary if you have an estimated tax payment amount. After all, the money you’ll be paying for fines may be better used for something else like an investment. Learn more about how to calculate an estimated tax penalty so you can avoid it in the future.
Estimated Tax Penalty | How to Compute for It
Estimated Tax Deadline
— Lauren Ray (@LaurenMatches) April 11, 2017
The deadline for freelancers and business owners to make their estimated tax payment is set every quarter – April 15, June 15, September 15, and January 15 to be precise. IRS also allows monthly payments and can be advantageous to those who want a fixed amount of tax deducted to their monthly income. It results in organized budgeting per month and closely monitored dues.
Fine Paid in Estimated Tax Penalty
Although the estimated tax payment deadline is set quarterly, you won’t incur any penalty until the year ends. That said, you’ll have plenty of time to calculate your annual taxable income provided you kept tab of everything. In case you fail to pay the supposed amount, a four percent interest rate will serve as a multiplier to the amount unpaid.
Estimated Tax Computation Example
Lorenzo is a self-employed businessman earning $30,000 quarterly and spends $10,000 in business expenses. Assuming his business is not seasonal and remained consistent the whole year, his net profit stands at $20,000. His annual net profit will be $80,000. Being an independent contractor, Lorenzo will have to pay both the self-employment tax and income tax. Now, this is how you calculate the tax:
Step 1: Self-employment tax: ($80,000 x 0.9235 x 15.3% (Social Security and Medicare)) = $11,303.64
Step 2: Deduction for half of the self-employment tax = $5,651.82
Step 3: Standard deduction for a single person = $6,350
Step 4: Deduct the Personal exemption = $4,050
Step 5: Total the Taxable income ($80,000 – $5,651.82 – $6,350 – $4,050) = $63,948.18
With his taxable income figured out, it’s time to check for his income tax. You can refer to the 2018 tax rates when calculating. Since he is single, he will have an income tax of around $9,525. Add that to his self-employment tax of $11,303.64; he must pay around $20,828.64 annually as this will help avoid the penalties. He can pay a minimum of 90 percent to avoid the penalty, but he’ll have to settle the other 10 percent eventually. If he can pay 100 percent of the amount, which translates to $5,207.16 quarterly, the better.
Means of Payment
Sending your payment to the IRS is very easy. You can pay by credit card, use the Treasury Department’s online bill payment system, or by check. Do note the following:
Check – Address it to the United States Treasury. Use the 1040-ES payment vouchers. Also, do not forget to indicate your Social Security number in the memo field. Lastly, avoid using IRS as the recipient since it makes your payment vulnerable to theft.
Credit Card – The perk of using a credit card for your payment will always be on time. However, it is a requirement to use an authorized third-party payment service that charges additional service fees, which might cost you a bit more.
Treasury Department – It takes weeks to register but once you’re all set up, deducting the fund on your checking account gets done in no time.
Here’s an overview of how to calculate your estimated tax penalty courtesy of SSK Advisory:
Paying for estimated tax penalties may be challenging, especially for freelancers. However, keeping track of the formula will make the accounting side a lot easier. Start by making a habit of keeping receipts and an excel sheet, so you can immediately input all income and expenses that come your way. Three months is a hefty amount of time to fulfill these requirements, so try not to cram. This may also work to your advantage since you’ll be able to track every dollar that comes in and out of your pocket.
Have you paid estimated tax penalty before? What adjustments did you make? Share your experience in the comments section below!