Leaving employment for self employment changes when tax is paid as much as how much. The federal system expects payment throughout the year rather than at filing.
The system is built around pay as you go
Federal income tax is designed to be collected as income is earned, which employers accomplish by withholding from each paycheck and remitting on the worker's behalf.
Self employed individuals have no employer performing that function, so they make estimated payments directly on a schedule set in federal rules.
The obligation is not optional or triggered by preference. Underpayment during the year can produce a penalty even when the return is filed and paid on time.
Quarterly periods are not equal quarters
The four estimated payment periods do not divide the year evenly, and the due dates fall at intervals that surprise people expecting a clean quarterly rhythm.
Each payment covers income earned in its period, so a taxpayer with uneven income across the year cannot simply divide an annual estimate into four equal parts.
An annualized income method exists for taxpayers whose earnings are concentrated in part of the year, and it requires additional calculation on a specific form.
Self employment tax is the larger surprise
Self employed individuals owe both the employee and employer portions of Social Security and Medicare tax through self employment tax on net earnings.
That obligation applies in addition to income tax, and it is calculated on business profit rather than on gross receipts.
Newly self employed people who set money aside only for income tax routinely find the total owed considerably higher than they planned for.
Safe harbor rules define adequate payment
Federal rules describe payment thresholds that protect against an underpayment penalty, generally tied to a percentage of the current year or prior year liability.
The prior year measure is useful for taxpayers whose income is unpredictable, because it uses a known figure rather than an estimate of an uncertain year.
Thresholds differ for higher income taxpayers, and the specific figures are set in federal rules that are periodically adjusted.
States and record keeping run in parallel
Most states with an income tax operate their own estimated payment systems with separate schedules, forms and thresholds that do not always match the federal dates.
Deductible business expenses reduce the profit on which both taxes are computed, which is why contemporaneous records matter more than they do for a wage earner.
Because the calculations depend on individual circumstances and the rules change, a licensed tax professional should determine the amounts for any specific situation.