Since it’s the New Year and I was reminded of it, I tweeted out that people should remember to pay their quarterly taxes. I got a lot of questions! So I decided to make a short post summarizing this stuff for freelancers and small studios in the indie space.
First, a huge disclaimer: I’m not an accountant or a tax professional, just someone who has been running small businesses for a little while. This is not comprehensive advice, just a quick overview of the basic stuff for anyone who needs that. They don’t teach this stuff in school or anywhere else, for some reason! Also this is all just US-based advice. Other countries probably have it easier.
OK, so! If you’ve worked a Real Job before (a salaried or hourly “W4” position), you might think you’ve paid your taxes every April, simple. Not quite true! What actually happens is that your employer sends a piece of every paycheck to the IRS (called “Withholding”). You’re paying throughout the year, but you *file* in April. That’s why most folks get back refunds when they file taxes — this process tends to err on the safe side of tax payments. When you’re hired you set up your withholding, and then you forget about it, generally.
However, if you’re in a Realer Job, like being self-employed as a freelancer or a member of a small LLC, this process doesn’t happen. Instead, because the IRS wants their cut of your money as you earn it, you’re generally required to pay quarterly estimated taxes. This doesn’t involve any paperwork — it just means you send a check to the IRS by the 15th of April, June, September, and January, paying your taxes for the previous quarter. They’re called “estimated” taxes because you’re supposed to figure out the total amount you’ll owe by the end of the year, and pay the IRS 25% of that each time. Then, when April comes around, you file like everyone else, and the IRS figures out whether you guessed right or not.
Let’s get this out right now: this process sucks. Especially in games, it can be difficult to know what you’re going to earn throughout the year, and if you guess wrong the IRS will penalize you. What a stupid system.
You will always avoid penalties in three cases: if you owe less than $1000 in tax, or if you pay them at least 90% of what you owe (so basically you have a 10% window to err within), or if you just pay 100% of what you owed last year. If your income doesn’t fluctuate too much, this is pretty easy to do.
Also, let’s say your studio normally makes a relatively small amount of money through the year — long tail on your back-catalogue titles. Then in the 4th quarter, something big happens. You ship a game and your revenue spikes. Or your Untitled Mongoose get optioned for an animated show. Or you sign an Epic deal, and the Battlebus drops fat sacks of cash right onto your house (I’m reliably informed that’s how that works). It’s OK — the IRS will not penalize you for not foreseeing that, you just have to pay the adjusted amount of taxes on your fourth-quarter payments.
If you do get penalized, you’ll pay the IRS another 6% of whatever taxes you end up owing. Some folks skip this process and eat the fee, but for me, 6% is enough that I find it worth it to pay them every quarter.
How do you figure out how much you will owe? This is unfortunately really tricky. If you have a complicated setup you will want to hire an accountant to figure it out, or just err on the side of caution and pay 100% of your previous year’s taxes. It sucks for self-employed people because you can’t just look up the tax rate and go “oh OK, I made $56k, so I pay x% of that, easy”. You also have to account for self-employment tax, and social security payments. (If you’re employed, your employer takes care of part of the tax bill. If you’re self-employed, though, you have to pay both the employer and employee rates — again, this situation is terrible for freelancers).
I have a spreadsheet that breaks it down for me, calculates my regular income tax plus self-employment, and tells me what I should pay each quarter. It overestimates, because I hate the prospect of getting a surprise tax bill. It’s a very rough calculation, though, and again — you’re better off hiring an accountant. (I have a fantastic accountant, but because he’s so great he charges a lot of money. I have him do the actual filing paperwork, but not pay my quarterly taxes because I’m cheap.)
For me, it’s more complicated than for most (hopefully) — I was part or full owner of three different businesses, at one point spread across three different states (thankfully down to two businesses and two states, now). Which brings me to another wrinkle — this isn’t just for federal taxes. Most states require you to also pay state taxes quarterly. Figuring out state taxes is generally easier, but remember to also pay them! Both the IRS and most(all?) states will let you pay your estimated taxes quickly and easily online with a direct bank draft.
OK, that covers the situation if you’re a freelancer. If you’re a small studio, though, you might have a couple of other things to worry about — first, 1099s.
For any contractors you paid during the year, you have to file a 1099-MISC form, as long as you paid them over $600 and didn’t use PayPal or another online payment processor. 1099 forms are due by January 31st for the previous year — it’s basically a way for the IRS to make sure the people you pay are paying tax on that money. So, if you hire a hairdresser on contract for $35,000 to make you look 🔥 🔥 🔥 at the DICE Awards, you have to tell the IRS that you paid that person. You’ll need to get all the taxpayer information from them, and generally you do this by asking them to fill out a W2 form and send it back to you. That form has name, address, and taxpayer ID number, which you’ll need for your 1099s. There are online services for filing 1099s— I was just recommended Tax1099.com, for one example. It’s very easy, you just fill out the information and they send it to the IRS for you, and give you copies to send to your contractors. It’s pretty cheap, too, definitely worth it.
If you paid via PayPal or another service, they’re already required to report payments to the IRS, so you don’t have to file 1099s. However, payment services will take a cut of what you pay to contractors, so they end up bearing the burden in that case. Definitely ask your contractors which method they would prefer.
Second thing businesses have to worry about: additional state and local taxes. Generally, if you’re a single person or a small LLC, your business taxes and personal taxes are the same on the federal level. But some states, counties, and cities have additional payments that businesses have to make. Make sure you know about these!
And then third, if you’re a business, remember that you pay taxes on your profit, not your revenue. So if your Epic deal brings in $50k, but you spent $35k on your hairdresser, you can report the $35k as a business expense (please god talk to a real accountant before you do this) and you only have to pay taxes on $15k. This is the one bright side of running your own business — all those 1099s you file mean you have to pay less tax.
Please let me know if you have a question I can answer, or if I got something wrong! And again, remember: I don’t know what I’m talking about. If your stuff is at all complicated, get an accountant. If you’re bigger than a small LLC, you’re too fancy for me, and this probably doesn’t apply to you (you should have a payroll company that handles it all, anyway).