Planning Income Tax Prepayments: How to Stay Liquid

You've had a good year, the projects keep coming, and your account looks healthy. Then a letter from the tax office arrives: a back payment for last year, plus prepayments for the current one – and suddenly five-figure amounts are due within a few weeks. Not because you've managed your money badly. But because income tax for the self-employed arrives with a delay, and nobody deducts it from your revenue automatically.

The good news: prepayments can be planned. In fact, they're among the most predictable items in your liquidity plan – once you know when they're due and how to build them in.

Why prepayments catch freelancers off guard

The basic principle: tax on profit, not on revenue

Employees pay their income tax continuously through payroll withholding – they never see the money. As a freelancer, you receive the full amount in your account, and the tax office collects its share later. The tax is based on your profit, i.e. income minus business expenses. So only part of what's sitting in your account is actually yours.

The time lag: assessment, back payment, prepayment

The typical sequence: you file your tax return, the tax office issues the assessment. That results in a back payment or a refund for the year that has ended. At the same time, the tax office uses this assessment to estimate roughly how much tax you'll owe in the current year – and sets prepayments accordingly. These are usually due in several instalments spread across the year. The exact amounts and dates are in your prepayment notice.

The trap in year two

The second or third year of self-employment is usually the most critical. In the first year there are often no prepayments, or only low ones, because the tax office has nothing to base them on. When the first assessment arrives, several things come together: the back payment for year one, the prepayments for year two – and if the assessment only lands in the middle of the year, the instalments that have already passed can become due retroactively. It feels like you're paying for almost two years in a short space of time.

Building prepayments into your liquidity plan

Step 1: Set your planning rate

How much tax you owe on your profit depends on your personal situation: marital status, other income, church tax and more. For planning purposes you don't need an exact figure – you need a planning rate that errs on the high side rather than the low side. It's best to agree this rate with your tax advisor. A tool like THA·ONE is a planning aid, not tax advice within the meaning of the German Tax Advisory Act (StBerG) – the tax details belong with your tax advisor.

Step 2: Enter the known dates

If you have a prepayment notice, you have the simplest form of planning: fixed amounts on fixed dates. Enter each instalment in the month it falls due – not as an annual total, but as an individual outgoing payment. That's the only way to see whether there's actually enough money in your account in the month it's due.

Step 3: Estimate the back payment

For the year that has ended but hasn't been assessed yet, the calculation is: estimated tax liability (profit × planning rate) minus prepayments already made. What's left is your expected back payment. Schedule it in the month you expect the assessment to arrive – if in doubt, earlier rather than later.

Step 4: Set money aside monthly instead of panicking quarterly

The prepayment may only come around every few months, but your profit is generated every month. So: transfer a fixed share of your profit to a separate tax account every month. How to organise this in practice is described in the article on the 3-account method for tax reserves. VAT, by the way, is a separate topic with its own rhythm – more on that in the article on the VAT reserve.

Step 5: Adjust when things change

Prepayments are based on the past. If your profit grows significantly, the instalments are too low and the next back payment will be bigger. If your revenue collapses, you may be prepaying too much and tying up liquidity you need right now. In both cases it's worth talking to your tax advisor about an adjustment – and running a scenario with the new figures in your liquidity plan.

Worked example: Lena's second year

The following example is entirely fictional; the figures are rounded and serve only as an illustration. We'll assume a flat planning rate of 25% of profit – an assumption for the example, not a real tax rate.

Lena is an IT consultant in her second year of self-employment. In her first year she made a profit of around €48,000; no prepayments had been set yet. Her expected back payment: €48,000 × 25% = €12,000. In year two she expects a similar profit; once the assessment comes in, the tax office sets prepayments of €3,000 per quarter.

Further assumptions: the assessment arrives in July. The back payment and the two retroactively due instalments for the first half of the year (€6,000 in total) are payable in August, the remaining instalments in September and December. Lena has monthly income of €6,000 (excluding VAT) and €2,000 in business expenses, i.e. a profit of €4,000. She draws €2,500 for personal use – leaving a surplus of €1,500 before tax. Account balance at the start of the year: €5,000.

What the example shows: Lena is working profitably, and her account grows steadily from January to July. Without a reserve, she still slips into the red in August and doesn't get back out by the end of the year – because in year two, tax for almost two years falls due. With a reserve built up in year one (in the example, €1,000 per month, i.e. 25% of €4,000 profit), the same August is uncomfortable, but not a problem.

A second point stands out: according to the planning rate, €1,000 of Lena's €4,000 monthly profit belongs to the tax office. Her €2,500 draw and the reserve fit together – but only if the reserve is actually transferred every month. Without it, the €1,500 surplus looks bigger than it really is. You only see connections like this when taxes appear in the plan month by month.

How to find out where you stand

If you don't have a liquidity plan yet, a simple grid is enough to start with: twelve months, expected incoming payments, ongoing outgoing payments, tax dates. For a first impression of how long your cushion will last, you can use the free liquidity quick check. If you want to go deeper, work with a 12-month liquidity plan with scenarios – there you can lay a best case and a worst case for the back payment side by side, for example, and track the tax reserve as an actual-vs-target comparison.

More important than the tool is the habit: update the figures once a month, transfer the tax reserve, check the next due date.

Conclusion

Income tax prepayments aren't a surprise – they're a delay. The tax arises with every euro you earn; it's paid later and in lumps. If you know about this time lag, you can compensate for it: set a planning rate, enter each instalment in the month it's due, estimate the back payment and set money aside monthly. This is especially worthwhile in the second year of self-employment, when the back payment and prepayments coincide. Sort out the tax details with your tax advisor – the liquidity behind them is something you plan yourself.