Income tax generally must be withheld near the time that earnings are received. Some tax filers, however, work for themselves and do not have taxes automatically withheld. Self-employed individuals who need to prepay their federal income tax throughout the year can do so by estimating and paying their tax on a quarterly basis.
Self-employed individuals must also report and pay Social Security and Medicare taxes on their federal income tax return. If the total taxes are not prepaid on a timely basis, an additional penalty is added to the balance shown on the yearly income tax return.
Estimated tax requirement
Income tax prepaid during the year is referred to by the IRS as estimated tax. Since an underpayment of estimated tax is potentially subject to a penalty, it is important to keep track of your taxes on an ongoing basis. There is no penalty if your total balance due is less than $1,000 when your income tax return is filed. Even if you owe $1,000 or more, a penalty exception may apply.
If you owe $1,000 or more with your tax return, there is no penalty if the amount of tax already paid in is equal to or greater than the lesser of the two following amounts:
- 90 percent of the total tax shown on your current tax return
- 100 percent of the total tax on your tax return last year
Unless you are certain that a penalty exception applies, up to four quarterly payments are advised. IRS Form 1040-ES is used to pay your estimated tax. Form 1040-ES consists of four sections referred to as payment vouchers. A voucher is filed with a payment for any quarter in which you have self-employment earnings that increase taxable income. If your self-employment income is inconsistent, you may not need to make all four payments.
Tax withholding is generally treated by the IRS as if withheld evenly throughout the year. If your self-employment income is concentrated in certain quarters, IRS Form 2210 may be filed with your annual tax return to calculate your withholding requirement for each specific quarter. For instance, if most of your self-employment income is earned later in the year, Form 2210 may be used to show that little or no tax is due from earlier quarters.
Many self-employed workers need assistance in estimating how much to prepay during the year. For more information, contact Capital Accounting And Tax Service Inc or a similar company.