I started doing freelance work on the side last year and made about $15k. I know I need to make estimated tax payments but the whole process seems confusing. How do you calculate what you owe? What happens if you underestimate? Are there any tax saving techniques specific to side income that I should know about?
Estimated tax payments are due quarterly: April 15, June 15, September 15, and January 15. You need to pay if you expect to owe at least $1,000 in tax after withholding. The general rule is to pay 90% of current year tax or 100% of prior year tax (110% if AGI over $150k), whichever is smaller.
For $15k of side income, you'd owe self-employment tax (15.3% for Social Security and Medicare) plus income tax. So roughly $2,300 in self-employment tax plus whatever your marginal income tax rate is on the profit. You can deduct half the self-employment tax and business expenses to reduce the taxable amount.
If you underestimate, you might owe penalties. The penalty is essentially interest on the underpayment. It's not huge but it adds up. You can avoid penalties by using the safe harbor rules (paying 100% of last year's tax or 90% of current year's tax). I use Form 1040-ES worksheet to calculate my payments.
One tax saving technique for side income is to set up a solo 401k or SEP IRA. You can contribute up to 25% of net business income (20% for SEP) as an employer contribution, plus $22,500 as employee contribution if you have a solo 401k. This reduces your taxable income significantly.
I just increase my W2 withholding at my main job to cover the estimated taxes from my side hustle. That way I don't have to deal with quarterly payments. You can submit a new W-4 to your employer asking them to withhold extra. Much simpler than making separate estimated tax payments.
Keep good records of all business expenses. Things like home office deduction, mileage, supplies, software subscriptions, portion of phone/internet, etc. These reduce your net profit and therefore your tax liability. The QBI deduction (up to 20% of qualified business income) can also help reduce taxes on side income.