If you make a substantial amount of money from a side gig or freelancing, you likely have to make quarterly tax payments — or risk serious penalties.
The IRS has reported an increasing number of people who face estimated tax penalties. The number of people who paid estimated tax penalties, which apply if you underpay your taxes, jumped from 7.2 million in 2010 to 10 million in 2015, a nearly 40% increase.
While making quarterly tax payments may help you avoid problems come tax time, there may be other ways to manage your side job taxes without running into issues with the IRS.
To figure out how much you owe in side job taxes, you need to use Form 1040-ES (Estimated Tax for Individuals) from the IRS. Complete the form’s worksheet to identify the following information for that tax year:
- Adjusted gross income
- Taxable income
- Tax credits
Using your tax return from the previous year can be a good starting point. Individuals typically have to make quarterly tax payments if they expect to owe $1,000 or more in taxes when they file their return.
Philip Taylor, a certified public accountant and founder of Part-Time Money, said you should save a portion of your income to satisfy side hustle taxes.
“I’d recommend 20% to start,” Taylor said. “If you’re expecting a particularly high side hustle income — say, over $150K — then you may want to bump that up to 25% to 30% to be safe. A good rule of thumb is to use your effective tax rate from your previous year return.”
If your side hustle income fluctuates, you may need to complete more than one Form 1040-ES. For instance, you may need to fill out Form 1040-ES for each quarter if your income suddenly increases or decreases.
When it comes to side job tax reporting, there are three ways to manage your taxes.
1. Make quarterly estimated payments
Quarterly estimated payments are one of the most common ways to pay side business taxes. To satisfy the IRS, you have to pay taxes as you earn income throughout the year.
“So, when you earn money through a side hustle (enough to create a $1,000 tax liability), you should start making estimated payments as soon as possible,” Taylor said.
But you do have some more wiggle room in your first year after starting a side hustle.
“The IRS won’t penalize you at the end of the first year of your hustle if you’re paying taxes (through a primary employer’s withholding) that meets 100% of your prior year tax liability,” Taylor said. “This ‘safe harbor’ rule will essentially bail most first-year entrepreneurs out of having to make estimated payments. Always consult your particular CPA for advice here, though, as he or she knows your particular situation.”
When and how to make estimated payments
You have to make quarterly payments four times a year by set deadlines.
|Payment Period||Estimated Tax Deadline|
|Jan. 1-March 31||April 15|
|April 1-May 31||June 15|
|June 1-Aug. 31||Sept. 15|
|Sept. 1-Dec. 31||Jan. 15 of the following year|
After using Form 1040-ES to figure out how much you’ll owe, you can make payments several ways:
- Online: Pay from your bank account with IRS Direct Pay.
- Credit card: You can pay online with a credit card through the IRS’ partners: PayUSATax, Pay1040 or OfficialPayments.
- Phone: Pay with a debit or credit card by calling:
- PayUSATax: 844-729-8298
- Pay1040: 888-729-1040
- Official Payments: 888-272-9829
- Mobile: Use a mobile device to make payments through the IRS2Go app.
- Cash: Pay a tax bill in cash if you owe $1,000 or less by registering online at www.officialpayments.com/fed and visiting an approved location. Make payments at participating 7-Eleven, Ace Cash Express and Casey’s General Store locations. Service fees apply.
- Check: Mail in a check or money order. Look at Form 1040-ES to see where to send the check since it depends on where you live.
What is the underpayment penalty?
For the 2019 tax year, the interest rate on underpayments for individuals is 5%. The underpayment penalty is an interest charge for not paying the full amount owed.
2. Adjust W-4 withholding
If you don’t want to make estimated payments, consider adjusting your W-4 to withhold more money from your paycheck.
A W-4 is the form you complete when you start work with a new employer. It tells your employer how much to withhold from your paycheck each pay period for federal income taxes. You can use the IRS’ Tax Withholding Calculator to estimate how much needs to be withheld from each paycheck to satisfy tax requirements. Once you know how much needs to be taken out, you can fill out a new W-4 form. Under step 4C, you can add extra money you want withheld from your paycheck. Then, submit the completed form to your employer’s human resources or payroll department.
Adjusting your W-4 withholding eliminates the need for estimated taxes, so you only need to worry about your taxes once a year when your federal and state returns are due in April. But keep in mind that there are some downsides to this approach.
“This (adjusting your W-4 withholding) can get tricky as your side hustle income may fluctuate wildly,” Taylor said. “Having more regular control of your tax payments by using the quarterly 1040-ES would likely help to make your payments more accurate.”
3. Take a tax hit in the new year
Not everyone needs to worry about estimated tax payments or changing their paycheck withholding. Another option is to skip both these approaches and instead, just file the annual return and pay the taxes that are due in April.
With this approach, you have more control over your money, and there’s less hassle to worry about. However, if you don’t pay enough taxes through estimated taxes or withholding from your paycheck, you could be subject to hefty penalties.
Because of the potential penalties, just filing your return and paying your taxes in April is only a good idea if you owe less than $1,000 in taxes when you file your return. Or, if you paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the previous year, whichever is less.
The following tax strategies are typically best for these situations:
- If you earn a substantial amount of money or if your income fluctuates from month to month: Make estimated tax payments.
- If your income is modest and steady throughout the year: Adjust your W-4 withholding.
- If you earn only a small amount from your side gig and owe less than $1,000 at tax time: Pay your taxes when you file your annual tax return.
If you’re still not sure which is right for you, consult a professional. They can help you identify your best approach for managing your taxes and how to structure your business so it works efficiently.
Having a side gig can be a great way to boost your income, increase your savings and pay down debt. However, it’s important to pay attention to your side job taxes to avoid nasty surprises when you file your tax return.