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Thread: When to begin paying taxes? (discussion about estimated tax payments)

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    Default When to begin paying taxes? (discussion about estimated tax payments)

    So I am graduating college this year and just started stripping this month. I have been a dependent all my life and have never made enough to have to report taxes. This year though I definitely will. I read that as an independent contractor you need to pay taxes every 4 months. April 15th is coming up and I don't know whether I should pay or not. I have no clue what I am going to make the rest of the year since I just started dancing. Should I just guess or wait till the next quarter to pay?

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    Default Re: When to begin paying taxes?

    Melonie is going to give you a much better answer than mine.

    Go ahead and pay an estimate. You don't want to have to pay the fines.
    If you think school is hard, try being stupid.

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    Default Re: When to begin paying taxes?

    ^^^ the basic premise is that the IRS expects every taxpayer to 'pay as you go' in one form or another. Where employees is concerned, this means that the employer withholds X dollars worth of 'estimated taxes' out of every paycheck and sends it in to the IRS on the employee's behalf. Then at the end of the year the employee fills out their tax return, which calculates the actual tax owed. This is reconciled against the sum total of 'estimated tax' money that was sent in throughout the year via paycheck withholding. Depending on the difference, the employee either gets some of that estimated tax money refunded, or gets to cut a check for additional tax money.

    Independent contractors basically have to follow the same system, but in their case the 'employer' and 'employee' are essentially the same person. This means that the independent contractor must do themselves what the 'employer' (or employer's payroll system) does ... estimate the amount of taxes due, and send in 'estimated tax' payments on a regular basis. But where traditional 'employees' have 'estimated tax' payments sent in weekly or bi-weekly or monthly depending on how often they receive a paycheck, the IRS cuts independent contractors some slack from the paperwork side anyhow. For independent contractors, only four quarterly estimated tax payments are due per year ...

    earnings from Jan-Feb-Mar ---> estimated tax payment due April 15th
    earnings from April-May ---> estimated tax payment due June 15th
    earnings from June-July-Aug ---> estimated tax payment due September 15th
    earnings from Sept-Oct-Nov-Dec --> estimated tax payment due January 15th of next year

    the IRS has a really simple form for independent contractor estimated tax payments ... 1040-ES. Actually, all you need to send in with your check is the quarterly payment vouchers (at the end of the 1040-ES form)



    The hard part is figuring out what sort of tax rate percentage to use when figuring out your estimated tax payments. One component is straightforward - the self-employment tax. This basically consists of both the 'employer's' share and the 'employee's' share of Social Security and Medicare tax - and will be equal to right around 15% of your total income no matter how much money you earn.

    Figuring estimated income taxes is a bit more difficult, since the tax rate depends on total earnings, marital status, dependents, deductions etc. For a single dancer with no kids, who is not a homeowner, who doesn't have much going in the way of stocks / bonds / investments, the percentages shown on Schedule X of the estimated tax form are pretty close (probably high by a few percent because there will always be deductions available). For example, a full time dancer earning say $1000 a week will probably wind up paying an IRS federal income tax rate in the 20% ballpark.

    So every time the estimated tax due date approaches, you need to do a quick calculation. For example the next estimated tax payment is due in June on April and May earnings. In this example, the dancer would have nine weeks worth of $1000 per week earnings = $9000 for the quarter ... and the estimated tax payment due to the IRS would be $9000 * (15%+20%) = around $ 3,150

    Besides the federal tax due to the IRS, if you live in a state that levees a state income tax you will also have to send in a separate estimated tax payment voucher and separate check to the state tax agency. Your sig doesn't list which state you live in, so the best I can do is point you at a very rough chart of all state income tax rates.



    Also, in addition to the federal income tax, and the 42 states with a state income tax, there are also a handful of cities that also levee a city income tax - which requires sending in yet another estimated tax voucher and payment every three months. New York City is one of these, and the only one that I am really familiar with.


    Both the IRS and the state tax agencies understand that it is difficult for new independent contractors to accurately estimate both their earnings and their tax rate. Therefore there is a 'first year exemption' from penalty charges if it turns out that the total amount of estimated tax checks sent in is significantly below the actual taxes that will be calculated on the end of year tax return. However, underpaying the amount of quarterly estimated taxes, or failure to make estimated tax payments at all during the first year, does not reduce the amount of money you will actually owe in taxes next spring. For the dancer in my example, it would only trade paying in $3000 or $4000 in estimated taxes every three months for having to pay in a huge lump sum like $15,000 or $20,000 all at once next spring when your tax return must be filed.

    Because of the 'first year exemption', and the fact that you only worked a week or two during the first quarter, I would recommend that you follow your own advice ... wait until June before filing your first estimated tax payment, but include the extra week or two of earnings from the first quarter along with your second quarter earnings when you calculate the amount of estimated taxes to pay. Having 11 or 12 weeks of dancer earnings to 'average out' when you make your first estimated tax calculation in early June will provide a whole lot more accurate guesstimate in regard to your expected annual earnings level thus the effective federal income tax rate that will apply. Basically, you're going to average out those 11 or 12 weeks worth of earnings to arrive at an average weekly earnings level, and then project that average over the 40-41 weeks that you will be working in 2008 to estimate your annual earnings level. From there you can take an educated guess on your federal income tax rate percentage from Schedule X on the 1040-ES form.

    However, as Bella points out, after your first tax return is filed next spring, you will no longer have the 'first year exemption' working for you. Beyond that point, if the amount of each quarter's estimated tax payment is less than 90% of the actual tax amount due, you can be charged penalties and interest by the IRS. However, by that point, you will have been able to develop a pretty good idea of what your average earnings will be, as well as a pretty good idea of how your filing status, deductions etc. will affect your actual income tax rate percentage.

    ~
    Last edited by Melonie; 04-01-2008 at 06:43 AM.

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    Default Re: When to begin paying taxes?

    Thank you for all the info! So it is better to always overestimate how much you need to pay and over pay? If you do overpay do you get money back at the end of the year?
    Thanks again, that helped a lot!

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    Default Re: When to begin paying taxes?

    ^^^ actually, the ideal point to operate at is to pay 91% of your actual tax liability in the form of 'estimated tax' payments. However, this is extremely difficult to do, and will result in penalties if you guess wrong by 2% LOL. In the real world nobody can plan that accurately.

    Overpayment of 'estimated tax' payments actually results in you providing the IRS with a 'free loan' of your money. Yes, any excess in payments will come back to you the following April in the form of a tax refund. However, had you not made those overpayments and had deposited the money in a bank account instead, you could have been earning interest.

    IMHO the best option is to make estimated tax payments based on calculations using the best available financial info ... which in theory will result in the amount of 'estimated tax' payments exactly equalling the amount of actual tax liability.

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    AudreyLeigh
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    Default Re: When to begin paying taxes? (discussion about estimated tax payments)

    Sorry to threadjack but I have a question Mel. Since my husband and I are filing jointly my taxes are different right?

    This quarter Ive only made $7277. My husband has his taxes set at 0 deductions pretty much so that the money taken from HIS checks will cover MY taxes. Do I still need to send in a check for 35%? Should he have his taxes at 3 deductions? (me, him, daughter) or just 1 (him) or what? Which do you think would work best for our situation?

    I get confused on this tax stuff since our taxes are so different...

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    Default Re: When to begin paying taxes? (discussion about estimated tax payments)

    you are correct that, because you file a joint return, the total amount of 'estimated taxes' which needs to be paid by you plus withheld from hubby's paychecks can be 'shared' between both of your incomes versus both of your income tax liabilities. If hubby claiming zero deductions to artificially increase his automatic paycheck withholding is enough to cover your own tax liabilities as well as his, then that is a super-easy way to legally avoid having to separately file quarterly estimated tax payments.

    But keep in mind that, because you are married, the fact that you are on a trend that will lead to a $30,000 total income for yourself does not mean that your tax rate will be that of a single person earning $30K. Instead, the total of your own plus hubby's incomes must be added together, with the 'married filing jointly' tax rates then applying to the total. From that standpoint, hubby's own tax withholding may be on the short side since his employer is unaware that you also have significant income that will increase hubby's effective tax rate percentage. And between self-employment tax plus income tax on your own earnings, your own effective tax rate is likely to be in the 25-30% ballpark ... meaning that your first quarter tax liabilities may be in the $2,500 ballpark. You may want to do some quick calculations to see if hubby's zero deductions withholding is anywhere near adequate to cover this along with his own likely effective tax rate percentage.

    I only knew of one dancer who effectively used this approach. But to get the required amount of 'joint' tax withholding out of her hubby's employer, her hubby had to have his employer's payroll system do a flat tax withholding percentage of 34% ... which in conjunction with his Social Security tax and health insurance withholding and 8% state income tax withholding left hubby with less than 1/2 of his gross earnings in every weekly paycheck. Most husbands have psychological problems seeing more than half of their paychecks disappear to cover the tax liabilities of their dancer wives !
    Last edited by Melonie; 04-01-2008 at 05:26 PM.

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    AudreyLeigh
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    Default Re: When to begin paying taxes? (discussion about estimated tax payments)

    Hes in a high tax bracket. He makes around $140k a year. He has a LOT taken out (our return this year - federal is $6,700) because he had a deduction of 1 and when we filed he could claim 3. Same with state (we got back $2800)

    I would think with the lower deduction of 0 we should be ok. May owe a little at the end of the year but not too much. I just dont want to send in 35% of my income and hes having all this money taken out and were going to have a huge return again. id rather keep that money to myself in my own savings account...

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    Default Re: When to begin paying taxes? (discussion about estimated tax payments)

    ^^^ agreed that overpayment of estimated taxes should be avoided precisely because of the reasons that you state. It would also appear thay there is enough money being withheld from hubby's paycheck that an extra $2,500 or whatever is needed per quarter to handle your own estimated tax liabilities wouldn't be a problem.

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