If you've recently taken on a part-time contracting gig to earn some extra money, you may be excited about having a new stream of income and enjoying the relative ease with which you can now pay bills. Unfortunately, this extra income can come with some extra costs as well. While most W2 jobs will withhold federal and state income taxes (along with FICA taxes for Social Security and Medicare) from your wages, self-employment requires you to make these payments on your own -- either through estimated tax payments due quarterly during the calendar year or in a lump sum before April 15 of the following year. What are your options if quarterly estimated tax payments don't fit into your budget? Read on to learn more about paying estimated taxes and what you can do to maintain steady cash flow without incurring IRS penalties.
When do you need to pay estimated taxes on a quarterly basis?
Although it's possible you'll owe estimated federal or state taxes if you have any income that isn't subject to withholding (as W2 wage income is), it's not a certainty -- and if you have enough tax withheld from your primary job's paycheck to cover any additional estimated taxes you'd need to pay before the following year, you shouldn't need to take any further action until tax time. Those who usually get a hefty refund at tax time may find that their current withholding settings are sufficient to cover their additional income as well.
However, if you tend to owe at tax time (or get only a small refund), quarterly payments may be necessary. Those whose income withholdings amount to less than 90 percent of the total tax owed for that year (or 100 percent of the tax owed for the previous calendar year) may be assessed penalties on top of any unpaid taxes. Making quarterly payments can save you money by eliminating these fees and penalties (as long as your quarterly payments and the amount withheld from your paychecks that year are enough to cover at least 90 percent of your taxes owed).
What are your alternatives to paying quarterly estimated taxes?
If you're finding it hard to drum up the extra cash to pay your estimated taxes every three months, there are alternatives that could help you avoid penalties and interest without creating as much of a ripple effect in your monthly budget.
One of the easiest alternatives to quarterly payments involves increasing your wage withholdings. If you already have a good idea of how much you'll earn (in salary and contractor pay) for this calendar year, you can take advantage of one of the calculators on the IRS's website to determine how many exemptions you should be claiming on your federal W4 form. Although this will decrease the amount you receive in your regular paychecks, this decrease will be more spread out (and likely have less of an impact on your budget) than regular lump sum payments that come along only every three months.
For further assistance, contact local tax preparation professionals.