Freelance and contract workers need to file regular income reports and pay quarterly taxes. Missing a deadline or failing to file can come with stiff financial penalties. That is why this article will provide a quick overview of required reporting and some organizational tips to make the task manageable.

Being a freelancer comes with so many benefits. You’re in charge of your own schedule, you can work from home, choose your clients, and you’re even in charge of paying your own taxes.

When you’re a freelancer, taxes are a bit more complicated as most freelancers pay their taxes throughout the year instead of just in April.

So, should you pay your taxes quarterly, or once a year?

The answer is… Yes and No!

If you’re a freelancer who owes $3,000 or more to the CRA in the current and previous two tax years, you must pay quarterly estimated tax payments. In general, payments are due on March 15, June 15, September 15, and December 15. 

• How can you Keep up With your Quarterly Taxes?
• How much Should I set aside for Quarterly Taxes?
• How can I Save my Quarterly Taxes?
• How do I Manage my Freelance Income?

How can you Keep up With your Quarterly Taxes?

1. Budget for Taxes

The best way to pay your quarterly taxes stress-free is to budget for it!

As a freelancer, there are many perks to the job, such as making your own hours or taking on as much or as little work as you’d like. However, one trade-off to this type of work is that, unlike salaried employees, income tax and payroll deductions like the Canada Pension Plan and Employment Insurance are not withheld at the source.

Read Also: How to Get Gigs as a Freelance Graphic Designer

This means that, as a freelancer, you must pay all of your income taxes while also contributing to the employee portion and the employer portion of CPP and EI.

This is why it’s so important that you budget for your quarterly income taxes. If your marginal tax rate is 30%, a good rule of thumb is to set aside 30% of your earnings. If every time you receive payment, you take 30% and put it in a separate account, it’ll make paying those quarterly installments a breeze because all of the money will be ready to go.

2. Simplify Your Payment Options

The CRA gives you three options to calculate the amount of your quarterly tax instalment. By using the first two options, you base your instalments on your 2017 taxes or on an estimate of your 2018 taxes.

However, if you choose the latter option, watch out! Underestimating your 2018 taxes means the CRA will charge you interest based on a higher installment than was needed.

That’s why we recommend always using the third option. Under this option, the CRA calculates the amount of your instalment and sends you the calculation as a reminder. The total for the year will equal your previous year’s instalment base.

By paying the amounts shown on the CRA notice, you won’t be charged any installment interest, provided that you pay on time.

You should receive two reminders from the CRA—in February for the March and June instalments, and in August for the September and December instalments. However, if you don’t receive a reminder that doesn’t mean you don’t have to pay. Call the CRA to confirm the amount you owe.

You can also use the CRA’s calculation chart for the present year. This chart walks you through taxes, credits, Canada Pension Plan contributions, and Employment Insurance premiums, then advises you on how much you owe.

3. Set Up Automatic Deductions

If you fail to pay your quarterly taxes on time, the penalties can add up fast! In fact, the CRA charges interest on the deficient amounts as if you owed the money. If this interest charge adds up to over $1,000, they will add an extra charge on top of that. Yikes!

Of course, this should be avoided at all costs. So, what’s the best way to make sure you pay your quarterly taxes on time? Set up an automatic payment from your bank account to the CRA.

If you’ve followed our first tip and have been setting aside 30% of your earnings in a separate account, you can allow the CRA to debit this account automatically, eliminating any headaches when it comes to paying quarterly taxes.

4. Hire a Professional

As a freelancer, chances are that you’ve got a lot on your plate. From finding clients, to marketing your services, and everything in between, it’s probably a safe bet to say that accounting probably isn’t your number one priority.

However, no business can be successful without the proper management of cash flow, and paying your taxes is a big part of that. So why not free up your time to focus on what you do best and still ensure that your books are appropriately managed?

By hiring a professional accountant, the amount of money you may save in tax deductions and avoiding late fees can be well worth the cost. For example, a professional account will make sure to note your quarterly payments on your annual tax return so you get credit for them and don’t accidentally pay them twice.

How much Should I set aside for Quarterly Taxes?

Being self-employed comes with unique tax responsibilities, including budgeting for the taxes you’re going to owe the Internal Revenue Service (IRS) at the end of the year.

When you do not have an employer withholding your taxes from your paycheck, you must be responsible for calculating your tax burden throughout the year and setting aside enough money to cover your payments.

It can be challenging to calculate how much you’re going to owe in taxes, particularly if you just started freelancing or aren’t sure how much you’ll be earning. Learn more about what taxes you owe as a freelancer and how to budget for your quarterly tax payments.

When to Pay Estimated Taxes

When you have taxes withheld from a paycheck, the IRS receives those payments at regular intervals throughout the year. You are expected to do the same thing as a freelancer by paying estimated taxes. These are quarterly tax payments that you send to the IRS every three months.

You must pay estimated taxes throughout the year if you are earning a freelance income and expect to owe $1,000 or more at tax time. These payments should be the tax you owe on your income for the quarter that just happened.

Estimated tax payments are due by certain dates. Estimated taxes for the year are generally due on:

• April 15 of the current year
• June 15 of the current year
• September 15 of the current year
• January 15 of the following year

You can pay estimated taxes online or by mail.

Depending on your income and the tax you owed the previous year, the IRS may impose additional tax penalties if you don’t pay your quarterly taxes on time, or if you do not pay enough in estimated taxes. However, even if you have underpaid your estimated taxes, you likely won’t need to pay tax penalties if:

• Your estimated tax payments equal 100% of your tax burden the previous year
• You paid at least 90% of your tax bill for the current year
• You owe less than $1,000 in taxes after subtracting your withholdings and credits^.

Remember, paying estimated quarterly taxes does not excuse you from filing taxes by April 15 the next year. You must still file your federal, state, and local taxes. Once you calculate how much you have paid in estimated taxes, you will be able to determine whether you still owe additional taxes or are entitled to a tax refund.

Calculating Tax Payments for Freelancers

When you are a freelancer, you aren’t just responsible for paying your income tax. You must also pay self-employment tax.

Self-employment tax is your FICA taxes—the Medicare and Social Security taxes that your employer would normally withhold from your paychecks in addition to income tax. When you’re employed, you pay half and your employer is obligated to pay the other half.

When you are self-employed, you are considered both your own employer and your own employee. This means that you have to foot the whole bill yourself. Self-employment tax is 15.3% of the first $137,700 of income you receive, plus 2.9% of anything you earn over this threshold.

Because freelancers must budget for both income tax and FICA taxes, you should plan to set aside 25-30% of your taxable freelance income to pay both quarterly taxes and any additional tax that you owe when you file your taxes in April.

You can use IRS Form 1040-ES to calculate your estimated tax payments.

Estimating Taxable Income

You don’t have to save 20-30% of all your income because you have costs associated with running your freelance business. You’ll complete Schedule C at tax time, which will allow you to subtract your business expenses from your overall freelance income to arrive at your taxable income.

Keep track of your deductible expenses throughout the year, such as:

• Office supplies
• Travel expenses
• Mileage driven for business purposes
• Maintaining a home office

If you have been working as a freelancer for several years, you should have an idea of what your business expenses are and can adjust your estimated tax payments accordingly.

If this is your first year freelancing, you can estimate how much you should deduct. It’s typically safer to estimate low rather than high in order to avoid owing significant additional tax in April.

Once you deduct these expenses from your anticipated income, you can estimate the percentage of your income that you need to set aside for quarterly tax payments.

Budgeting for Taxes

In order to pay taxes as a freelancer, you need to regularly set money aside, both for quarterly payments and for any additional tax you owe when you file in April. There are a few different ways you can do this.

Set Aside Money When You’re Paid

Rather than trying to guess how much you’re going to earn, or scramble to find the money you need to pay your tax bill, you can decide what percentage of your income you intend to pay in estimated taxes. Then, set aside that amount from each payment you receive as a freelancer.

The easiest way to do this is to set up a savings account that you’ve earmarked for taxes. Link that savings account to the checking account in which you deposit your freelance income, then automatically transfer a portion of that money to the savings account each time you make a deposit.

This is essentially a save-as-you-go plan, which works well for an inconsistent income and the realities of your day-to-day budget.

Pay at the End of the Month

Depending on the frequency with which payments come in, it can be a headache to remember to transfer some of every single payment you receive. An alternate method could be to calculate how much money you earned last month, then set aside 25-30% of it before you begin paying the next month’s bills.

This tactic assumes that you’re already saving some of your income and your account isn’t empty, or won’t become emptied when you transfer the tax money. If you spend everything that comes into your account, set aside money for taxes before you begin paying your bills.

Estimate Your Earnings

You can also estimate how much you think you’ll earn for the entire year at the beginning of the year, then calculate 25-30% of that and divide by four going forward. This is the amount you’ll remit to the IRS each quarter.

This tactic works well if you’ve been freelancing for a few years. You can look at the 1099-MISC forms you received last year, then use these to estimate what you’ll earn in the upcoming year.

For example, if you estimate that you’ll make $60,000 in freelance income after you subtract business expenses, you can plan to pay 25% of that, or $15,000. This means you’ll need to set aside $3,750 each quarter for your estimated taxes.

Paying Estimated Taxes Early

Keep in mind that you don’t have to wait until the quarterly estimated tax due dates to pay your taxes as a freelancer. You just can’t go beyond these dates without incurring a penalty.

Freelance income is often inconsistent, so it may be helpful to pay estimated taxes when you know you have the money, rather than waiting until the quarterly deadlines. If you have a particularly high income one month, go ahead and pay your taxes early.

For example, if the next tax deadline is September 15th, but you receive several payments in August and don’t expect any in September, pay your third quarter taxes in August. Otherwise, you risk spending money that you should have been saving for taxes.

By paying your taxes early, you know exactly how much you have to spend for the rest of the year.

How can I Save my Quarterly Taxes?

Make paying your quarterly taxes estimated easier by always having the money in the bank. 

When you’re employed, every pay period your employer sends a portion of your pay to state and federal tax authorities to cover income, Social Security and Medicare taxes. Not so, for the independent contractor, or freelancer, from whom no taxes are usually withheld.

1. Freelancers don’t get to hold on to that extra money for long

They are usually required to make an estimated tax payments, typically on a quarterly basis. But since most of our bills come around monthly, making quarterly payments can be tricky!

Making a plan (and sticking with it) to save for quarterly taxes can help you stay on track. After all, if you save too much, the worst that can happen is that you’ve paid yourself a nice tax refund.

2. Make monthly transfers into a savings account

In this approach, you budget for your taxes like any other expense. Usually when you file your taxes each year, you can calculate your quarterly tax payments for the next year at that time. Calculate how much per month you will need to save to always have enough when quarterly taxes are due.

But since each “payment” is to your own savings account, you have to be disciplined about actually doing it. If you are not disciplined about saving and frequently empty your savings account, have a separate account that you never touch except for taxes.

Note: You can also simply pay your taxes to the government on a monthly basis, but the downside of that is that you are letting the government hold your money longer rather than earning interest yourself. Also you may need to make two payments per month–one to the federal government and one to your state government.

3. Transfer a percentage of each payment to a savings account

If your self-employed income is sporadic, transferring a percentage of each payment into a savings account can be more practical than a monthly amount. However, be sure that you are transferring enough.

Remember that you will have to pay self-employment tax (Social Security and Medicare) of about 15 percent, so that plus whatever your federal and state (if applicable) income tax rate is a good amount to put away.

You may have deductions that will reduce your self-employment income and taxes in the long run, but depending on how you set up the payment system, you could also owe taxes in a quarter when your income was low or nonexistent. So it’s better to put away more than you need, rather than less.

4. Have your tax refund applied to the next year’s taxes

This strategy reduces your quarterly estimated taxes, making it a bit easier to make those payments. But remember, you are letting the government hold your money for a year. In the previous two strategies you were earning interest on your money. Not so here. However, if you are undisciplined about saving, this might be the safest way to go.

5. Have more income tax withheld from other employment income

Similarly, withholding a greater amount of taxes from any employment income that you–or your spouse–earn means the government gets to keep your money longer. And if you owed a large amount the federal or your state, it may be required that you make quarterly taxes anyway.

However, this can be a painless way to “save” for taxes. When you fill out your W-4, you can adjust your exemptions so you have more withheld or you can simply state an extra amount you would like withheld from your pay. It doesn’t matter that this paycheck was not earned as an independent contractor. 

When figuring out how much more to withhold, don’t forget those self-employment taxes. When you are self-employed, they are paid with your income taxes (unlike in employment where they come out separately as payroll tax) so extra withholding will cover them as well.

How do I Manage my Freelance Income?

One of the toughest things about freelancing is figuring out how to manage your freelance income so that you’re not standing in line at the local food bank during the lean times (although that’s an option, and it’s certainly happened!). Here’s a how-to guide to help you smooth out the roller-coaster ride of your cash flow.

Open a Separate Business Account With Multiple Savings Accounts

Let’s talk about bank accounts for a minute. In addition to your personal checking account, it’s a good idea to set up a separate business account. This makes it easier for you — and your accountant, if you have one — to manage your freelance income. This will make your accountant very happy, come tax season.

In addition to your main business account, most banks will allow you to set up multiple savings accounts for free, so why not take advantage of this ability?

Even though you can manage your freelance income using bookkeeping software or spreadsheets, squirreling your savings away in separate accounts isn’t a bad idea, if for no other reason that it might make you think twice before getting your hands on money that you’re setting aside for stuff other than splurges.

Especially if, like me, you put the checkbooks and debit cards in one of those “perfect” places that you can never find afterward.

Here’s a suggested list of bank accounts to consider opening:

• Main Business Account: Make this the highest-yield savings account your bank offers, so that any cash that’s in there is earning interest while it’s sitting there. When a client pays you, this is where you deposit the check. From this account, you:
  • Pay yourself
  • Pay your business expenses
  • Set aside money for taxes, retirement and emergencies
• Savings Accounts to Open Under Your Business Account: Open the following savings accounts under your main business account, and then once a month, after you pay yourself, transfer a designated amount into each of them. Think of these transfers simply as additional bills to be paid. I believe that most banks will even allow you to automate these transfers, which makes it a pretty painless and darn convenient way to manage your freelance income.
  • Retirement Savings: This can be a traditional retirement account such as a 401K, or you could even start doing a little basic investing with this money, since  (hopefully) it’s going to be in there for awhile.
  • Tax Savings: This is the holding area for yearly taxes
  • Emergency Savings: This is your buffer for lean times.

Set Up an Emergency Fund

Your emergency fund should be the first thing you think of when you have any cash left over after your expenses are paid. Having a year’s worth of expenses in reserve is a worthwhile goal for effectively managing your freelance income. Your emergency fund will be there for you in case your income drops below what you need to keep your commitments.

In addition, having an emergency fund means that you can turn away clients who don’t quite feel right, or if a good client runs into a financial tight spot and can’t pay you immediately, you’ll have a cushion to carry you through. And of course, there are those unforeseen things that just happen — called emergencies — such as a pet getting sick or an unexpected car repair.

Treat yourself like an employee

Decide how much you can afford to pay yourself, then on a regular basis, either write a check to yourself or set up an automatic transfer from your business account and deposit it in your personal checking account. It is from your personal checking account that you pay things like rent, food, and other living expenses that aren’t related to the business.

When deciding how much to pay yourself, it’s a good idea to stay on the frugal side and only pay yourself enough to cover your living expenses plus a little extra, then sock anything that’s left over at the end of the month into your emergency fund.

Project Upcoming Monthly Income and Expenses

Part of effectively managing your freelance income is figuring out how much money you’re making and spending each month, and then using those numbers to estimate what the next year might look like. When you’re calculating your projections, it’s a good idea to base your budget on your lowest monthly business income and highest monthly business expenses from the previous year.

This is like assuming the worst possible scenario, and hopefully, if your income’s trend is generally upward, estimating conservatively in this way should give you a bit of a buffer, which, once again, you can sock away in your emergency fund. It’s impossible to have too much money in that emergency fund!

Break Up Client Payments for Big Projects

If you’re working on a big project that extends over multiple months, consider billing your client on a time-interval or a “milestone” basis. That way, if your client flakes out or can’t pay you immediately, you’re only out a partial payment instead of the whole thing at once. It also smooths out your income curve, making budgeting easier.

Also, if you need to exert a little persuasive power on a particularly recalcitrant client, you can calmly explain that they’ll get no more work from you until you’re paid from the last billing cycle. Hopefully, you’ll never need to use this tactic, but it’s there if you need it.

Be creative in finding ways to generate additional income

There’s a whole movement called the Share Economy that you can tap into for additional sources of cash at little or no cost to you. If you have an extra room in your house, consider renting it out to travelers, or rent your car when you’re not using it. 

Or consider investing some of your leftover money in things that appreciate in value, such as musical instruments, that you can sell later for a profit. The more different streams of income you have, the less of a hit you’ll take during a dry spell in freelancing.

If possible, live on only one income

If you have a partner with a job or other regular stream of income, do your best to live on that income alone, and either save or invest everything that you earn from freelancing.

Establish a foundation of thrift

You never know when you’re going to have a lean month, or even a lean year, so make a habit of living on the cheap. Sign up for Netflix instead of paying for cable TV. Buy clothes at a thrift store, or check out local garage sales for things like furniture, sports equipment and appliances.

Read Also: How to Earn Money With Illustrations

Avoid buying fancy tires and rims for your truck that are going to cost a fortune to replace later. Trade stuff that you don’t want for stuff that you do want on Listia.

Resist “lifestyle inflation”

This is the temptation to increase your spending as your income increases. If you find yourself at the end of the month with money left over, stash it in your emergency fund or invest it back in your business by, say, paying for some online advertising or attending a seminar in your field of expertise.

Prioritize spending

Many financial experts recommend sitting down and writing down your expenses. Prioritizie them according to importance and pay the most important ones first.

Pay down your debts

Take a piece of paper and divide it into columns. List your largest monthly payment toward the left, then go smaller and smaller until your smallest monthly payment is at the far right. Double up on the smallest payments until that debt is gone.

Then take the money that you’re no longer spending on that debt and start doubling up on payments on the next debt. Keep going until all of your debts are paid off.

Finally

Freelancing is a rewarding experience and can be a lucrative business if you’re able to sustain and maintain a good amount of cash flow and manage it properly.

You don’t need a fancy education in finance to manage your money as a freelancer, just remember to follow the basics:

• Spend less than you earn – track your money with a budget.
• Check in with your business money once a week.
• Save for emergencies and future growth.
• Save for taxes.
• Use the right tools for you – automate.

You don’t need a fancy education in finance to manage your freelance money.