Estimated tax payments for freelancers

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Q. I started working as a freelancer this year, and someone just said I should be paying estimated taxes. Is that true?
— Freelancer

A. We’re glad to see you want to do this right.

The general rule is that an individual is required to make payments of estimated taxes if the amount of tax they pay through withholding will not cover their tax liability, said Laurie Wolfe, a certified public accountant with Lassus Wherley in New Providence.

You said you work as a freelancer, which implies that you will be treated as an independent contractor — as opposed to an employee who would be subject to withholding tax, Wolfe said.

If you do not make the required estimated payments, you will be charged a penalty based on a percentage of the underpayment for each of the four quarters.

In order to avoid an underpayment of estimated tax penalty each quarter, Wolfe said, you must pay 25 percent of either 90 percent of the current year’s tax liability, or 100 percent of the prior year’s tax liability. You’d have to pay 110 percent of the prior year’s liability if you are married and make more than $150,000 per year, or if you are single and make more than $75,000 per year, she said.

Wolfe said as a freelancer you may earn income unevenly throughout the year, so there’s an alternative calculation that is allowed in this case.

“This annualized installment method may be used if the individual estimates their tax at the end of each payment period based on a reasonable estimate of income, deductions and credits,” Wolfe said.

There are a couple exceptions to the penalty, she said.

You do not have to pay estimated taxes if your tax liability will be less than $1,000 for the year or you did not have a tax liability for the previous 12-month period. Waivers of penalty are also a possibility in the case of hardship or following retirement or disability.

Wolfe recommends you calculate an estimate of your anticipated tax liability each quarter, or have an accountant do this for you. If you are married, the calculation is done on a joint basis, she said.

“Compare this figure with what you expect your total withholding to be during the year to see what the shortfall is, if any,” she said. “Tax withholding is considered paid evenly throughout the year — regardless of when it is actually withheld — unless the individual can establish when the taxes were actually withheld.”

She notes that included in the calculation estimated tax liability should be both income and FICA taxes from your earnings as a freelancer.

Wolfe said the states each have similar, but varying requirements, so be sure to check the rules.

“In New Jersey, you must pay in 80 percent of the current year liability over the four quarters with similar alternatives as the federal requirements regarding prior year tax and annualized methods,” she said.

Estimated tax payment due dates are: April 15, June 15, September 15 and January 15 (of the following year) on income earned through March, May, August and December, respectively.

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