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Sole Proprietor Taxes: Should You Pay Annually or Quarterly?

by Margot Carmichael Lester, Staples® Contributing Writer

Most sole proprietors bristle at the thought of calculating and paying federal and state income taxes more than once a year. “Once the money is in their bank accounts, they find it difficult to voluntarily hand it over to the government,” says Santa Monica-based CPA Bob Wheeler, author of The Money Nerve: Navigating the Emotions of Money.

Regardless of the heartburn it may cause, you don’t have a choice about paying self-employed, or sole proprietor, taxes — you have to. In general, solopreneurs who take a salary and withhold income taxes from it make payments (or get refunds) annually on this “W2 income.” Sole proprietors who don’t run payroll, however, must pay quarterly based on estimated income. (Learn more about taxes for self-employed people from the IRS.)

“Government statutes determine filing options,” says Josh Cahan, president of Augustine Corporate Solutions in Charlotte, NC. “There’s not much wiggle room.” Check with your tax advisor to understand the tax rules in your state, because they do vary.

What Is a Sole Proprietor Tax?

Solopreneurs who don’t withhold taxes from their paychecks are obligated to pay taxes based on income. It’s like the Medicare and Social Security taxes deducted from employee paychecks.

“Estimated tax payments are due quarterly based on business net income, interest, dividends, profits from investment sales, alimony, rental income, prizes, awards — essentially any income that you have not paid any taxes on,” explains Heidi Warren, manager of Brown Smith Wallace Small Business Services in St. Louis, MO. “If you expect to owe at least $1,000 in tax for the current year, you should file quarterly estimated tax payments.”

How Do I Estimate Self-Employment/Sole Proprietor Taxes?

Quarterly estimates can be based on year-to-date or prior year’s income. “You are subject to underpayment penalties if you don’t withhold or pay either 90 percent of the tax on the current year or 100 percent of the tax shown on the prior year — 110 percent when over $150,000 — whichever is less,” Wheeler notes.

You can do the math yourself or use the calculator in your tax preparation software, but it’s always best to check with a tax professional.

Creating estimates based on your previous year’s numbers makes the most sense for sole proprietors with predictable and/or steady incomes.

What If My Income Is Unpredictable?

For sole proprietors whose cash flow fluctuates, like freelancers and consultants, Warren suggests using year-to-date income for estimation.

“This will require that you have an updated and accurate profit and loss statement for your business, as well as year-to-date numbers from any other income sources you have,” she explains. “Real-time tax liability calculation will help ensure you pay only the actual tax due for the year, instead of paying too much or too little.”

How and When Do I Pay Self-Employment/Sole Proprietor Taxes?

Quarterly estimated payments for federal taxes if you’re self-employed or a sole proprietor are filed using Form 1040-ES vouchers, available online, at your local IRS office, or from your tax advisor or accountant. Get your state forms online or in person from your department of revenue, tax advisor or CPA.

Usually, payments based on the income of the previous quarter are due on April 15, June 15, September 15 and January 15. But there are many rules about when and how much to pay on a quarterly basis, so you should consult your tax advisor or accountant to verify the schedule.

Additional Benefits

Paying quarterly may seem arduous, but it keeps you on the IRS’s good side. And there are additional benefits: “As you keep your financial statements updated and do a quarterly tax liability calculation, you perform tax planning throughout the year instead of missing key tax savings opportunities by waiting to do so in April of the next year,” Warren says.

That will keep your accounting up to date, and make things a bit less taxing.

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