What Are Quarterly Self-Employment Taxes?

How Do Quarterly Self-Employment Taxes Work?

Federal law calls for collection of income taxes on a "pay as you go" basis, which means all taxpayers are expected to make payments throughout the year, as income is received.

Workers who get regular wages or salary typically accomplish this by having their employers withhold and forward a portion of each paycheck to the IRS. If you work for yourself or receive significant income from interest, investments or other passive streams, however, you may be expected to make quarterly payments toward your federal income taxes.

More precisely, if your income from self-employment (or other sources such as investments, interest and the like) generates enough income to warrant paying $1,000 or more in taxes, you may have to submit estimated tax payments to the IRS. Estimated tax payments are based on the income you expect to earn over the current year (that is, the taxes you'll file next April). If your state has an income tax, it may require quarterly estimated tax payments as well.

Quarterly estimated tax payments encompass two types of tax: income tax and self-employment tax, which covers your contributions toward Social Security retirement benefits and Medicare insurance.

The tax rate on income can range from 10% to 35%, depending on your income level.

The tax rate for Social Security contributions is 12.4%, and the Medicare rate is 2.9%, making the overall self-employment tax rate 15.3%. Social Security tax applies only to annual income of up to $147,000 (from all sources). Medicare taxes apply to all income.

Quarterly payments for each tax year are due on April 15, June 15, September 15 and January 15 of the following year. If these deadlines fall on weekends or holidays, taxes are due on the first business day afterward.

Calculating Estimated Tax Payments

Determining the amount of your quarterly tax payments requires:

• Estimating your income for the year ahead, using your previous year's return as a starting point
• Determining the taxes applicable to that income amount
• Subtracting applicable credits or deductions from your tax obligation
• Dividing your estimated tax obligation into four payments

These procedures will vary with your financial situation and income source(s) and can be complicated. IRS Form 1040-ES provides a detailed set of instructions you can use to figure your obligation, but you may want to consider using tax-prep software or consulting a professional advisor for assistance.

Prepayment Schedule Options

Recognizing that some forms of self-employment have earnings fluctuations that can make it difficult to come up with one-fourth of your annual tax obligation each quarter, the IRS gives you two options for dividing your estimated tax obligation into quarterly payments:

• Regular installment payments divide your annual estimated tax by four and call for equal payments in that amount every quarter.
• Annualized income installment payments let you structure quarterly payments in a way that better mirrors your income flow, paying as little or as much as you like each quarter, as long as your payments add up to your full estimated tax.

If, for example, your business is a food concession that derives most of its income from summer festivals and autumn fairs, you could opt to pay 0% of your estimated tax in April and June and 50% each in September and January using annualized income installment payments.

Penalties for Underpayment

If you fail to make quarterly estimated tax payments, if you are late on those payments or if your total annual payments are less than the amount you are required to pay, the IRS will charge interest on the shortfall, payable when you submit your annual tax return.

The specific charges depend on the amount of your underpayment, the amount of time it went underpaid and the interest rate applicable during the quarter(s) that your payment was delinquent. Interest rates can change quarterly; for the first and second quarters of 2023, they are set at 7% for individual taxpayers. Procedures for calculating interest payments can be found in IRS Form 2210.

Aside from a couple of exceptions, if you make estimated tax payments that cover the full amount you paid one year earlier (assuming that reflected tax on a full 12 months' earnings), the IRS won't penalize you even if your payments cover less than 90% of your tax obligation for the current year. Naturally, you'll have to pay any remainder of what you owe when you submit your tax return.

Exceptions are as follows:

• The IRS allows farmers and fishermen to prepay as little as 66.66% of their annual tax obligation without penalty, owing to the unpredictability of their income.
• If your adjusted gross income exceeds $150,000 ($75,000 if you're married and file separately), your withholding must be at least 110% of your total tax liability for the previous year.

Note that you also may be subject to a penalty if you miss any of your quarterly payment deadlines, even if your payments ultimately equal or exceed what you owe for the year.

Who Has to Pay Quarterly Self-Employment Taxes?

For tax year 2023, you must pay estimated tax if both of the following are true:

• You expect to owe at least $1,000 in tax for the year, after subtracting your withholding and refundable credits.
• You expect your withholding and refundable credits to be less than the smaller of:
  • 90% of the tax to be shown on your 2023 tax return, or
  • 100% of the tax shown on your 2022 tax return, assuming your 2022 tax return covers 12 full months of income.

How Do You Pay Quarterly Self-Employment Taxes?

You can submit quarterly estimated tax payments several ways:

• Set up a secure online account at IRS.gov/account, which you can use to set up direct payments from your checking account (and direct deposit of your refunds).
• Use the IRS2Go smartphone app.
• Visit IRS.gov/Payments for options to make one-time direct payments from checking, via credit card, or using a digital payment service such as PayPal. The site also provides instructions for paying in person, paying by check or setting up an installment plan.

The Bottom Line

If you're self-employed, there's a good chance you're required to make quarterly estimated payments that cover your income tax, Social Security and Medicare obligations. Working out your payment requirements and selecting a payment schedule for the first time can be challenging, but once you've worked out the approach that works best for you, you'll be able to anticipate quarterly payments and set aside the funds you need to meet them. Because the process can be daunting, it might be wise to work with a tax pro or use software that can help you get a system in place for paying taxes as you go.