The United States tax system is known as a “pay as you go” system which functionally means you may have to pay income taxes as you earn income or receive income (depending on your accounting method). Individual employees accomplish this by withholding payments every paycheck. Business owners accomplish this by making estimated tax payments. If you do not make enough tax payments throughout the year you will end up paying an additional tax underpayment penalty on your earned income.
Let's first go over the basics of underpayment penalties. Business owners and self-employed individuals must pay taxes as they earn income. The penalty for underpayment kicks in once a taxpayer owes more than $1,000 in tax (after subtracting tax withholdings and refundable credits) or if they pay less than 90 percent of the tax liability for the current year, throughout the tax year. If there is a spike in the income, you can avoid an underpayment penalty by paying 100 percent of the tax shown on the prior year's return.
The IRS states the easiest way to avoid this situation is to make estimated tax payments. To avoid the penalty, you must make an estimated tax payment in four equal amounts. If you run a business with uneven income throughout the tax season you can vary the amounts of payments to avoid or lower the penalty by using an installment method. The installment method requires the use of IRS Form 2210 which is commonly referred to as the Underpayment of Estimated Tax by Individuals, Estates, and Trusts form. A quarterly tax underpayment penalty is slightly different than an IRS 1099 late filing penalty.
Similar to payroll tax payments, estimated tax payments are due on the 15th day of the month following the end of the calendar quarter. Quarterly tax deadlines are the same every year: April 15, June 15, September 15, and January 15 of the following year.
As with all federal payment due dates, if the 15th falls on a weekend or holiday the payment will be due on the next business day.
The Internal Revenue Service has defined 2 situations that allow for a waiver for penalties.
There are also special situations when the IRS may waive the penalty but these situations are out of the ordinary.
The requirement to pay estimated taxes covers an extremely broad group. It includes individuals (including sole proprietors, partners, and S corporation shareholders) if they expect to owe more than $1,000 in taxes when they file their tax return. Corporations have the same requirements but a threshold of $500 instead of $1,000.
Anyone who receives a salary or wages and uses Form W-4 to withhold taxes will avoid the requirement of paying additional estimated taxes. If you are employed and also have self-employment income, there is a special line on the W-4 where you can enter an additional amount you want your employer to withhold.
There are several situations when you technically meet the requirements to pay the estimated tax but the IRS states the penalty doesn't apply.
To determine the penalty you can complete Form 2210. This is the "Underpayment of Estimated Tax by Individuals, Estates, and Trusts". At the very bottom of the form is the penalty formula. The total underpayment penalty depends on when the amount due is paid.
First, take the amount that was underpaid and multiply it by 0.01744. If you paid the penalty after 1/15/YYYY but before 4/15/YYYY, you can take the amount of the penalty and apply the following equation to reduce the amount owed:
The total figure for the Year x Number of days paid before 4/15/YYYY x 0.00008.
If you have already underpaid your income tax one of the options available is to let the IRS calculate the late penalty for you. If you meet the following criteria IRS will complete this calculation for you.
In most instances, it will not cost you more to have the IRS determine the penalty if you pay the amount due but the "pay date" identified on the IRS bill. While the IRS will typically complete this calculation for you, there are some situations where the IRS will still request you file a Form 2210
Interest is charged starting the due date of the amount you owe. This can get tricky because there may be multiple due dates. The first due date is the return date that the tax bill is due (even if you file an extension). The send due date is the penalty payment due date. This date will vary based on the penalty type and if there are multiple penalties.
Interest is due as it accrues which is why it is essential to pay an outstanding taxes as soon as possible. If you receive a note, then the interest will not be charged if you pay the entire amount by the "pay by" date.
The interest formula for underpayments falls into two categories: Standard and Large Corporate Underpayment.
The Standard formula applies to corporate and non-corporate underpayments. The interest rate used is the Federal short-term rate plus 3 percentage points. The current rate is published quarterly by the IRS. The Large Corporate Underpayment formula applies to underpayments of tax exceeding $100,000 by C-corporations. The interest rate is the Federal short-term rate plus 5 percentage points.
Even if you do not fall into any of the exception categories there is still an opportunity to reduce or eliminate the penalty in certain situations. While the situations vary, the one constant is you must file Form 2210.
There are 7 situations that may allow you to reduce or eliminate the penalty you owe when filing Form 2210.
The US Tax Code is applied equally to everyone but the penalty rules are particularly important for freelancers, self-employed individuals, and independent contractors because taxes are not often withheld from payments. At the end of the day, the key is to submit estimated tax payments by the appropriate due dates to avoid an underpayment penalty and interest. If you want to stay on top of your quarterly taxes and maximize your tax deductions, try our 1099 expense tracker software. We'll connect to your bank account and credit cards to organize all your write-offs.
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?