Today we’re going to venture into the often-overlooked realm of estimated taxes. Whether you’re a seasoned therapist or fresh out of grad school, if you’re self-employed, this is for you.
When it comes to financial health, understanding estimated taxes is kind of like understanding billing codes for your insurance claims – get them right, and you’ll be a happy camper; get them wrong, and you’ll be left frustrated by a financial surprise. Why? Because they’re how you pay tax on income not covered by withholding — think earnings from your practice, interest, rent, dividends. It’s the IRS’s way of saying, “Let’s share the pie throughout the year, not just at the end.”
So let’s get into it:
Who Needs to Pay Estimated Taxes?
If you’re self-employed, like most mental health pros, and you reckon you’ll owe $1,000 or more when you file your return, Uncle Sam expects you to make estimated tax payments.
Key Dates for Estimated Taxes
Estimated tax payments are due quarterly. For those of us who love scheduling, the four dates to mark are April 15, June 15, September 15, and January 15 of the next year. It’s a year-long commitment, like therapy.
And remember, tardiness or forgetting these dates can cost you in penalties — like a late fee for a no-show at your clinic.
Calculating Your Estimated Taxes
Let’s take an example of how you might go about this. The starting point is to take your net income (revenue minus expenses) so far this year. Suppose your net income from January through May is $41,667. If you divide that over 5 months (Jan-May), you get roughly $8,333 of net income per month. Now multiply that by 12 to get a projected net income as of the end of the year, so $8,333 x 12 = $100,000. Great! You’re on pace to make $100,000 for the year. Here’s how you would calculate your Q2 estimated tax payment.
Step One: Calculate Your Taxable Income
First, you need to calculate your expected adjusted gross income (AGI). In simple terms, AGI is your total income minus certain adjustments. For self-employed individuals, the most likely adjustment you’ll have is a deduction equal to one half of the self employment tax you’ll pay. To calculate your deduction, take your net income and multiply it by the following: (.9235 x .153)/2.
If you’re on pace to make $100,000, your self-employment tax deduction would be:
$100,000 x .9235 x .153 = $14,130
$14,130 / 2 = $7,065.
Then subtract that deduction from your estimated net income. So you’re AGI would be $100,000 – $7,065 = $92,935.
Note that if your self employment income is going to be over $173,470, the above formula needs to be adjusted slightly. Also, other common deductions you might have that would reduce your AGI would be for self-employed health insurance premiums, as well as deductible IRA contributions.
Next, subtract either the standard deduction or your expected itemized deductions. For instance, if you anticipate claiming the standard deduction and will file jointly with your spouse, the standard deduction will be $27,700 in 2023. Therefore, your taxable income would be $92,935 – $27,700 = $65,235.
Step Two: Determine Your Tax Using IRS Tax Brackets
For 2023, if you’re a joint filer, here’s how you’d calculate your tax (you can see all of the tax brackets here):
12% of the amount that $65,235 exceeds $22,001, plus $2,200. So:
$65,235 – $22,001 = $43,234
$43,234 x 12% = $5,188
$5,188 + $2,200 = $7,388
Your total income tax for the year would be $7,388.
Unfortunately, if you’re self employed, your tax bill doesn’t stop there. Next you need to calculate your self-employment tax (remember we calculated the deduction for self-employment tax previously). To calculate the self-employment tax, simply multiply your projected net income x .9235 x .153. So in our example above, $100,000 x .9235 x .153 = $14,130. If you were really paying attention, you’ll notice that the deduction we took above is equal to exactly 1/2 of your self employment taxes (bonus points if you caught that).
So if a married couple had $100,000 of self employment income, with no other sources of income, their total tax liability for the year is projected to be $7,388 + $14,130 = $21,518.
Step Three: Divide Your Tax By The Number of Quarters Remaining
Let’s say you had already paid $5,000 with your Q1 payment. Subtract that $5,000 from the $21,518 total to arrive at $16,518 – this is the amount of tax you have left to pay for the year. Divide this by three (since you have three quarterly payments left to make – Q2, Q3, & Q4) to get your estimated quarterly payment: $16,518 / 3 = $5,506.
Thus, your Q2 estimated tax payment would be $5,506.
You’ll then repeat this entire exercise again for the Q3 payment due 9/15 (factoring in your income from Jan-August) , as well as for the Q4 payment due 1/15 (factoring in your income from Jan-Dec). For each quarter’s projection, once you get your estimated total tax liability, you’ll want to subtract any payments you’ve already made for the prior quarters, and then divide that by the amount of quarters remaining.
Remember, this is a simplified example which doesn’t address state income taxes, and doesn’t account for other potential factors like credits you might be eligible for, or deductions beyond the standard deduction.
The IRS provides Form 1040-ES, Estimated Tax for Individuals, to help you estimate your taxes more precisely. And you don’t have to go it alone. Just as you are there for your clients, I’m here to help guide you through this. Remember, the right support can make any journey smoother.