It's that time of year (taxes)

I've been doing independant consulting for 3 months now, and start a new job (as an employee) in 2 weeks.  I need to pay taxes on my loot.  My current employer is 6 weeks behind on her payments.  (I'm not worried about getting paid.  yet).

When I file quartarly taxes, should I only include what I've been paid, or include outstanding invoices?

Snotnose
Sunday, April 4, 2004

It depends on how you are operating your business.  Read up on 'Cash vs. Accrual Accounting' for more info.

Scot
Sunday, April 4, 2004

Ask you accountant,  states would be the bigger issue.  I normally wait until the end of the year and then pay the penalty.  Unless you are rolling in 7 figures, it is unlikely to amount to much.

MSHack
Sunday, April 4, 2004

Scot's right that you need to base the answer on whether your business is operating under cash or accural accounting. If you're doing straight consulting/contracting work and not managing inventory, etc., then cash accounting probably makes more sense. And if you haven't set up official books for your business you're essentially operating a cash business by default.

[Usual disclaimers: I am not an accountant, and this discussion assumes you're based in the U.S.]

The basic rule with a cash-accounting business is that for tax purposes you receive income on the day it becomes constructively available to you, which usually means the day you receive a check in the mail or otherwise have the money in hand, regardless of whether you actually deposit it in the bank right away. So, assuming you are indeed operating on a cash basis, to compute your 1Q tax liability you're going to use all the income you actually received from 1/1/04 through 3/31/04. There's a worksheet in the tax guide that you use to extrapolate out your income for an entire year and pro-rate the tax -- basically you multiply your 1Q income by 4 and figure out what the total annual tax would be, then divide it by 4 to figure out what you have to pay now.

I assume you are aware that in addition to the usual federal (and possibly state and city, depending on your location) income taxes, you are also required to pay both halves of the SE (FICA and Medicare) taxes, which typically total 15.3% of your net (after deductible expenses) consulting income. (These taxes are themselves partly deductible, and there's a ceiling on FICA when you hit about $90K in one calendar year.)

To avoid penalties at the federal level, you need to make sure your quarterly payment (including any withholding) totals the lesser of 90% of your actual tax owed or 100% of the tax you would've owed in the equivalent period last year (actually 110% if your income is above a certain level). State rules will vary.

You need to be aware that for purposes of reporting self-employment income, the second quarter actually ends at the end of *May*, and your payment will be due by 6/15 or so.

Have fun :-)

John C.
Sunday, April 4, 2004

My accountant here in Texas tells me that I operate under the cash basis, so I don't pay taxes until I actually receive the money. I suspect that you likely operate under the same rules.

To keep things simple & clean, I make an IRS tax deposit every time I have my accountant cut me a paycheck. The IRS is the *last* bunch of people that I want to owe money to, so no matter what happens to my cash flow the IRS is paid up.

Mark Hoffman
Sunday, April 4, 2004

I should add that the best advice someone can give is find a good, trustworthy accountant and pay them to worry about this stuff. I majored in Accounting in college, but after so many years of being away from it, this stuff makes my eyes bleed. I just don't have the time to keep current with technology, run a business and keep track of the ever changing tax rules.

A good accountant, a good lawyer and a good banker are something every small business owner needs. But mainly the accountant!

Mark Hoffman
Monday, April 5, 2004

It's a cash business, and I'm not looking to be accurate.  I just attached 30%of what's I've currently invoiced  to my 2003 return, figuring 15% Social (In)security, fed, and state taxes.  It's close enough to keep me out of the penalty box, I don't have to worry about it again in 3 months, and I can fix it this time next year.

I never intended to consult long term, else I would have setup some sort of accounting system.  I've only got 1 more week of consulting, then I start a "normal" job.

Snotnose
Monday, April 5, 2004

Dude......The "ballpark figure" stuff will get you in trouble. The IRS isn't like your phone company when you're a few dollars short paying taxes. They're not nearly as nice about it.

15% is an absolute bare minimum since you have to pay 7.5% FICA for you and then your company has to match it. That's 15% right there. On top of that there is unemployment tax and a variety of state taxes if applicable.

Take it from someone who has been there before...Just go pay an accountant a few hundred bucks to straighten it out or else this could come back and haunt you.

The IRS isn't very efficient, but they are determined. They might not catch up to you until years later. By that time, the penalty and interest would have ballooned at a rate that would make a loan shark blush.

Been there...
Monday, April 5, 2004

It's not like I'm avoiding 2003 taxes, I'm prepaying some 2004 taxes.  All I want to do is not be penalized for underpaying when I do the full years taxes next year.  I figure 30% is low (why loan the government money?), but it's enough to keep me out of trouble.

Snotnose
Monday, April 5, 2004

Seriously, get professional advice.  The tax laws change so frequently that it's difficult to keep up with personal taxes, let alone corporate/self-employed rules.  If you own a business, it's foolishness not to hire a specialist because of the severity of the pentalties and huge hassle factor involved for cleaning up non-compliance.  A pro might even be able to save you some money in the process.

Jeremy
Monday, April 5, 2004

Snotnose, I understand where you're coming from, but I think you may have a misconception of how income taxes work (understandable, because it's absurdly complicated) and this might get you into trouble later. Honestly, the folks here are not trying to make life unnecessarily difficult, they're trying to help you avoid nasty surprises.

Contrary to what you wrote, you are not in fact prepaying taxes for 2004. Tax on your consulting profits in the first quarter of 2004 is DUE on April 15, 2004. If you don't pay the amount due by then, your payments are LATE and you may be subject to penalties. (I happen to have portions of my tax return and IRS instructions from 2002 in front of me, and there's a section in the instructions on estimated tax that reads, "If you do not pay enough during any [quarterly] payment period, you may be charged a penalty even if you are due a refund when you file your tax return.")

Now, it's generally fine if you guesstimate and *overpay* (though it does translate into a free loan to the government), but paying 30 percent of the amount you invoiced sounds low, unless you plan not to get out of the 15% Federal tax bracket this year (and that tops out at $28,400 if you're single).

Also, your message implies that the 30 percent estimated payment includes state income tax. Of course, state and federal taxes are totally separate things, so if you live in a state that assesses income tax, you need to send money to your state separately.

Not to sound like a doomsayer, but I'd really urge you to be careful here. If you've always received your income as W2 wages or salary, the tax changes you encounter when you first generate self-employment income can seem really bizarre, and you really don't want to fly blind and end up getting penalized.

John C.
Monday, April 5, 2004

You guys have totally ruined my day.  You've scared me enough that I'm going to actually try and figure out wtf I owe, and send it.

Jeez, one off the head comment about something you've already done, and suddenly you lose a day to some boring BS.

I guess it's a thanks, but a very grudging one.

Snotnose
Monday, April 5, 2004

"paying 30 percent of the amount you invoiced sounds low, unless you plan not to get out of the 15% Federal tax bracket this year"

He did say 30% of his invoice amounts, which is likely to put him into a very good position. You're all assuming that he has zero deductions, while he'll have at least the minimum deduction and quite probably more.

It is a good idea to get a handle on this type of thing, at least to understand the basics of how it works, but I wouldn't paint too much a doom and gloom picture. Depending on what you use for your books, most financial software makes this kind of thing very easy.

  --Josh

JWA
Tuesday, April 6, 2004

JWA, you're probably right, and I'm probably being overconservative, because deductions and exemptions will likely provide some buffer. It's probably because I remember the unpleasant experience a couple of years back of pumping my data through TurboTax only to get a screen at the end saying, basically, "Oops, you didn't pay enough in estimated taxes, now you owe this much plus penalties totaling blah-blah dollars. Would you like us to fill out the penalty form now so you can send it in with your return, or would you rather wait until the IRS contacts you to ask for the money?"

And it wasn't that I hadn't paid the estimated taxes on my business income; I think I had forgotten that I also needed to account for estimated taxes for interest and dividends I received that quarter, or some crap like that. Or maybe there was something I'd thought was deductible but turned out to be mistaken about. Anyway, I ultimately was able to jump through a bunch of hoops (using a different method the IRS allows for calculating due dates on estimated taxes) and get the penalty down to a whopping $2.

Not so bad in the end, but still, it's made me rather more cautious. I took two lessons away from this. First, add a little to the estimated tax payments just to be safe. Second, this stuff can be ridiculously complex and really requires professional help (besides which it's just not a good use of my time/energy).

Sorry if I ruined your day, Snotnose. I really hope the math works out OK for you and this turns out to be a false alarm. But I'm assuming that if the numbers don't work, you'd rather find out now than next year.

John C.
Tuesday, April 6, 2004

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