One of the biggest questions first-time contractors have is often “How do I pay taxes as a contractor?!” and while navigating the tax system can be a nightmare in even the best of times, it turns out that paying taxes as a self-employed individual isn’t as hard as you might think! Read on for a basic overview of what quarterly taxes are, how to pay them, and tips on keeping ahead of the payments.
First and foremost, some background information for anyone out there who isn’t yet contracting or who isn’t sure why exactly self-employed individuals have to pay taxes differently than anyone else. In a “normal” job, your paycheck has all your taxes (and healthcare and retirement, when applicable) automatically withheld, but as an independent contractor taxes etc. are not taken out of your paycheck. While this can be a good thing because your paychecks are larger than other people working at your same rate, it is good to keep in mind that, after taxes, you’re losing a good part of your paycheck. It is all too easy for new independent contractors to get into the habit of spending 100% of their paychecks, only to realize, come quarterly tax time, that they don’t have enough money left to pay taxes.
So, that being said, what exactly are quarterly estimated taxes? Well, they’re pretty much exactly what they sound like; 4 times a year, you make an estimated guess about how much you’ve made over the past quarter and calculate approximately how much you will owe in taxes, both state and federal. While this may sound difficult, we have found that there are a few simple things you can do to make staying on top of your quarterlies a breeze.
The easiest way to make sure you can always pay your quarterlies is to simply set aside a portion of your paycheck as soon as you get it! State taxes can differ slightly, but a good rule of thumb is to set aside 25% of each paycheck for federal taxes, and around 5% for state. Experiment with this as needed and adjust your percentages if you find you’re too low, but this amount works for most people. So, all together, you want to set aside a full 30% of your paycheck as soon as you get it. It might hurt a bit at first, but this will ultimately make it easier for you to budget your income and to not have to worry about taxes every quarter. The best way to consistently do this is to start an excel sheet for your income- every time you get paid, record the amount, date paid, and what 30% of the amount is equal to. Bonus points for also calculating how much to set aside for your SEP-IRA!
When it comes to setting aside the money for taxes, we have found that the most fool-proof option is to simply open a checking account that will be used exclusively for taxes. Just make sure you order an actual checkbook to accompany this account. If you’re someone who’s likely to be tempted to spend what you’ve set aside, maybe even go ahead and just throw away the debit card that you will receive with your new account. Just cut it up, and don’t give yourself the chance to spend any money from your tax account.
From here, paying your taxes is actually the easy part. About a week before the deadline (usually mid April, June, September, and January, but the specific dates change from year to year), set a few minutes aside to sit down and write your checks. It’s usually a good idea to double-check your numbers one last time, and the easiest way to do that is to simply add up how much you’ve been paid between the last time you paid quarterlies and the end of the previous month- for example, if you’re paying your mid-April taxes, you will be covering everything you made for the period between January 1 and March 31st. This is where that spreadsheet becomes crucial! Take your total income for the tax period, and find 25%. Then write a check to the IRS for that amount, and complete the accompanying form. Specific instructions, as well as the forms for each quarter can always be found on the IRS website.
Now it’s time to pay your state taxes. The process for this differs by state, but it will generally look very similar to the IRS process. Simply double-check your income once more, calculate 5% (or whatever number you have found works best), write a check for that amount, and follow your state’s instructions for mailing in your taxes.
There you have it- the relatively easy and fool-proof way to stay on top of your quarterly estimated taxes! As always, if you have a different and also awesome way of doing your quarterlies, we’d love to hear it, feel free to reach out!