Independent Contractor 101: Dealing with Estimated Tax Payments

What are quarterly tax estimates?

If you are new to the world of driving for Uber or Doordash, or one of the many other on-demand companies, you may be in for an unpleasant surprise when tax time rolls around. Next year, you’ll probably have to pay quarterly tax estimates. As an independent contractor, you’re self-employed, so you file an annual return but usually pay estimated taxes on a quarterly basis.

If you’re an independent contractor and you expect to owe more than $1,000 in taxes, the IRS will expect quarterly payments.

Basically, if you’re an independent contractor, when you file your taxes, the IRS estimates your taxes for the next year. They base the estimate on what you make this year. Then, each quarter next year, you send the IRS a check for 1/4 of that estimate. Luckily, if you drive for a living and take the mileage tax deduction, you probably won’t owe much in taxes. Even so, you probably want to have some money set aside to pay your quarterly taxes. If you don’t pay them quarterly, you’ll incur a penalty when you file your taxes.

 

Most of you who are driving are probably aware that you’re an independent contractor. This means that Lyft, Instacart, Caviar, Lime Bike, and all the other on demand companies, are not required to withhold taxes from your pay. Without that regular withholding, it is up to you to settle up with the tax man, and without proper planning, that tax bill could create a financial nightmare down the road. To avoid that, it’s better to have that money set aside and ready.

Fortunately, there are things rideshare and delivery drivers can do to make tax time less taxing, from taking advantage of deductions and retirement programs, to making those estimated payments to the IRS and avoid penalties. Here are some smart things you can do to deal with estimated tax payments.

Choose the Right Parking Place For Your Estimated Taxes

It is important to put money aside for tax time, but where you put that money matters a lot. Since the money is essentially already spent, you cannot afford to take any risk with it, so the stock market is out.

You can, however, eke out some income while you are waiting to make your quarterly payments. Parking your funds in a one or three month CD, or a high-yield savings account will allow you to earn a bit of interest in the interim, so your tax money will go a little bit further

Putting the Money Aside

Finding a suitable parking place for your estimated tax money is one thing, but finding the money itself is quite another. There are two different approaches to setting aside money from your freelance earnings, and each has its own set of benefits and potential drawbacks.

The first choice is to use your good months to offset that looming tax bill. When your earnings come in above your pre-established baseline, take a chunk of that money and put it in your high-yield savings account or other designed monetary parking spot.

The other choice is to treat your quarterly tax liability as just another monthly bill. If your total estimated taxes for the next year are $1200, having $100 a month shifted into a savings account will cover your estimated taxes.

Each approach has its benefits and drawbacks, and it is important to weigh the pros and cons carefully. Using your good months makes sense, but if your earnings come in lower than expected, you could be left struggling. The same applies to the monthly bill option – if you have a lackluster month, making that regular tax bill payment could be a real hardship.

Estimated Taxes For Part-Time Freelancers

If you work for Instacart, Lyft, or another company on a part-time basis but still have a regular job, you may be able to avoid making estimated tax payments altogether. Some part-time drivers and shoppers just increase the amount of withholding from their regular jobs, letting that money accumulate and using it to offset what they owe from their side hustle endeavors.

It can be hard to get the balancing act right, especially if you are new to the world of freelancing. Freelancers often do not know how much they will make for the year, so that makes paying estimated taxes somewhat of a guessing game. Guess too high, and you will get a big refund come tax time, but you will have lost access to your money in the meantime. Guess too low, and you could owe additional taxes and an underpayment penalty on top of it. It can take some time to get things right, but if you start buy setting a little bit aside every month for the tax bill, you should be in alright shape.

For more information, check out the IRS pages on Estimated Taxes and Tips on Making Estimated Tax Payments.