I’ve been a freelance writer for five years, and every year I’m convinced I’ve finally nailed it.
I mail my estimated tax payments to the IRS, but not before Googling “Where do I send my estimated taxes?” every single time.
Heck, I even have an emergency fund to get me through three months of rent should anything go wrong.
Then something went wrong.
Suddenly, I had a huge tax bill sitting in my lap.
I thought I did everything right. And now I’m paying Uncle Sam and his local cronies almost $10,000.
What This Freelancer Did Wrong (Because Admitting It is the First Step)
Accountants come in all shapes and sizes, and mine is pretty hands-off. I fill out a bunch of worksheets at the end of the year, she does the math, and then ships me a sheaf of papers to review and sign.
Each year, my accountant examines my tax return and calculates how much I should submit for the upcoming year in quarterly estimated taxes. At the end of the year, I usually owe a few hundred dollars — nothing to shake a tailfeather at.
But this year, I did really well. I hustled my freelancer behind more than I ever had, and picked up a few long-term gigs with rates higher than I’d been brave enough to charge in the past.
Except while my bank account was flush, I hadn’t communicated my great fortune to my accountant.
I assumed that by sending in my triflin’ estimated payments each quarter, I’d be 100% covered when annual filing came around.
Even worse, unlike in previous years where I had W-2 gigs scattered in — and chose to have the maximum tax withheld — this year I was all 1099, all the way.
I got into deep financial doo-doo, and I’ve been assured I’m not the only freelancer to experience this misfortune.
“I have a lot of new clients who come to me in March and say, ‘Here’s my income, I’m probably in the X tax bracket, so I’ve set aside this chunk of money,’” says Aaron Peters, a CPA in Northern Virginia who specializes in freelancers and small businesses.
Many freelancers “aren’t familiar with the self-employment tax, which in a lot of cases adds an additional tax burden depending on income level.”
So if you’re in, for instance, a tax bracket somewhere between 10% and 25%, you still have to pay another 15.3% of your income in self-employment tax.
Hi. My name is Lisa, and I forgot about the self-employment tax.
It’s OK if a Tax Bill Makes You Cry
Here’s how the math breaks down, and how I got through tax season without bursting into tears.
I had paid $2,800 over the course of the year through estimated tax payments. I didn’t pay any quarterly tax to my local government, because, until now, I hadn’t made enough to hit the threshold to require those payments.
When my accountant prepared my tax return, I owed:
- $5,005 to the IRS (trust me, I was offended by that extra $5)
- $2,187 to the District of Columbia
Then it was time for 2016’s quarterly payments.
As all self-employed folk know, April 15 is doubly difficult because it’s when annual returns from last year and first-quarter estimated payments for this year are due.
For the first quarter of 2016, I owed:
- $2,000 to the IRS
- $550 to the District of Columbia
All told, I needed to write checks to various government entities for $9,742.
I also owed my accountant $600 for preparing two Schedule Cs, one for freelancing and one for my now-shuttered clothing store. That brought my grand total to $10,342.
What I Did to Fix It
It was time to change my game plan. Big time.
During a recent visit to Penny Hoarder HQ, I had proposed a debt-repayment challenge for myself. Could I pay off all my credit card debt in six months? The staff was encouraging, of course. And I was encouraged by my financial situation.
Good thing I held off on that ambitious plan. I needed almost every penny I had earmarked for my credit-card project for my tax bill.
Where I got the money to pay Uncle Sam:
- $4,000 came from a savings account where I had stashed a windfall (thank you, family).
- $2,000 came from a savings account where I auto-deposit $25 a week — so, 1.5 years’ worth of auto-savings.
- $4,342 came from my checking account. I know, it was just all sitting around in there.
Yes, it was nice to have several thousand dollars in my checking account at all times. I felt secure. I felt like I could do anything.
And now I’m totally stocked up on tomato soup and grilled cheese supplies for the rest of my summer. If I’m going to be living lean until I build my savings back up, I’m at least going to do it with cheese.
The good news: I didn’t touch my emergency savings at all.
So if something really does go horribly wrong — I lose a client, I wind up in the ER, I crash a rental car — I have cash I can get to ASAP. I don’t have to wring my hands and count down the days until each client payment comes through.
What to Do if it Happens to You
If you’re faced with a large or unexpected tax bill, your absolute first step is still to file your taxes.
You might be tempted to hide from the IRS, but that’s your worst move.
If you don’t file, “the IRS files on your behalf with the worst possible scenario,” David Emmerman, a New York City-area accountant, says. “They’ll send you a bill and start levying your bank accounts.”
Here are the most common options you can choose from to get back into the black:
Pay It All
“Of all the creditors you can have, the IRS is the worst,” Peters warns. “It’s the most powerful.”
While it doesn’t happen often, the IRS can seize your assets and garnish your wages until you’re paid up, says Peters.
It can also throw down compounding interest and penalties on those unpaid amounts. Penalties for failing to file your taxes are typically in the 20% range.
If you have any cash saved, now is the time to use it.
That rainy day fund. Your travel fund. Your dream house savings.
Empty them out. Your dream vacation will wait for you to get there. The IRS will not.
My bank account feels a little light now that I’ve paid my bills, but I can still sleep (relatively) easily knowing I’m not in any extra debt because of my tax bill.
Set up a Payment Plan
If you don’t have cash sitting around, it’s time to call the IRS and make a plan.
If you owe less than $10,000 to the IRS, you can set up a payment plan without having to reveal too much financial information, explains Emmerman.
If you owe less than $50,000, you can still get a payment plan, but you’ll have to reveal more about your income and expenses.
The IRS typically wants you to pay off your balance within 60 months, says Emmerman. But remember, “just because you’re on a payment plan doesn’t mean you’re exempt from interest and penalties accruing.”
Interest rates are usually around 5%, and you’ll still be expected to file and pay your taxes in the years to follow — even if you still owe a balance on your payment plan.
One key to surviving a payment plan is to make sure you agree to a realistic monthly payment.
“You don’t ever want to get to a point where you miss a payment,” Peters says, which could cause interest and penalties retroactive to your plan’s start date.
You want to strive to pay the bill in a timely fashion, sure, but you “don’t want to get three months down the road and be in a world of hurt,” he warns.
Pay by Credit Card
If you’d rather owe your credit card company than Uncle Sam, you can put your tax bill on a credit card.
This option asks you to choose a payment processor through the IRS, which offer varying fees in the 1.5-3% range to process your payment. Then, you’re subject to the interest rate you agreed to with your credit card provider.
“The credit card does provide a nice option and a little bit of liquidity with the IRS,” Peters says. “If that’s the only option, it may not be that bad. But then the liability is still there.”
This last option should only be considered under the close advisement of your accountant.
“If you can pay shortly after the due date, it may make sense to skip setting up a payment plan and paying late instead,” Peters says.
A small penalty, say, if you’re waiting on a big check from a client that’s due a week after taxes are due, may be less of a burden than the fees associated with setting up a payment plan.
“It definitely depends on the individual,” he says.
The One Thing You Must Do So This Never Happens Again
“I never want to do this again,” I muttered as I slapped stamps on all the check-laden envelopes I mailed out in late March. “Never.”
I asked my roommates to say goodbye to my money as I walked to the mailbox. Then I asked the pros how to avoid tax surprises altogether.
“If a freelancer can go out and be proactive about how they manage their business, you know what problems you have ahead of time. You’re not going to be surprised by things,” Emmerman says.
He recommends setting aside and saving a full 30% of your freelance income to be prepared for tax season.
Then, make a date with your accountant when it’s not tax season.
“Use your tax return to plan for next year, but also check in in the late summer or early fall to look at your earnings and tax liability,” Peters advises.
That way, if you’re having an amazing freelancing year (or a really slow one), you’ll be ready to handle it when it’s time for the paperwork.
Your Turn: Have you ever been slammed with a huge, unexpected tax bill? How did you cope?
This post does not constitute tax advice. For specific advice, please see a tax professional.
Lisa Rowan is a writer, editor and podcaster based in Washington, D.C. She is grateful for all accountants, everywhere.