If you recently transitioned from a W-2 employee to an independent contractor, freelancer, or sole proprietor in Arizona, the biggest shock is often the self-employment tax. When you are a W-2 employee, your employer withholds income tax and covers half of your Social Security and Medicare taxes. When you are self-employed, no one is withholding anything, and you are responsible for the entire 15.3% Social Security/Medicare burden yourself.
What Are Quarterly Estimated Taxes?
The U.S. tax system operates on a "pay-as-you-go" basis. Because you don't have an employer withholding taxes from every paycheck, the IRS expects you to make payments four times a year: April 15, June 15, September 15, and January 15 (of the following year). These are paid using Form 1040-ES.
Who Has to Pay Them?
Generally, if you expect to owe $1,000 or more when you file your return, you must make estimated tax payments. If you fail to pay enough throughout the year, the IRS will assess an underpayment penalty—even if you pay your balance in full on April 15.
How to Calculate Your Payments
The safest way to avoid penalties is to follow the "Safe Harbor" rule. You must pay either:
- 100% of the tax shown on your previous year's tax return (110% if your adjusted gross income was over $150,000).
- 90% of the tax you will owe for the current year.
Estimating your current year income can be difficult if your business fluctuates. As your tax professional, I look at your year-to-date Profit & Loss statements to calculate the exact estimated payments you need to make to stay compliant without overpaying.
Don't Forget Arizona State Taxes
Estimated payments aren't just for the IRS; you must also make quarterly payments to the Arizona Department of Revenue (ADOR). Arizona's flat tax rate simplifies this slightly, but separating the federal and state payments is crucial for compliance.