Independent contractors are considered to be self-employed, even if they only work for a single client. Consequently, rather than relying on an employer to withhold their payroll taxes for them, such individuals are responsible for paying their own payroll taxes and making quarterly estimated tax payments to the Internal Revenue Service (IRS) in order to avoid being saddled with penalties and interest.
Independent contractors may certainly rely on tax software programs to help them calculate their estimated tax payments. But those looking to better understand the finer points of how the estimation process works can use IRS form 1040ES, along with the accompanying instructions and the estimated tax worksheet.
- Self-employed individuals are responsible for paying their own payroll taxes and making quarterly estimated tax payments to the IRS in order to avoid penalties and interest.
- Independent contractors may rely on tax software programs to help them calculate their estimated tax payments, or they can adopt a more hands-on approach and use the traditional IRS form 1040ES, along with the accompanying instructions and estimated tax worksheet.
- Independent contractors may determine their estimated tax payments either by making quarterly estimated tax payments totaling 100% of their previous year’s tax liability or by making quarterly estimated tax payments totaling 90% of the current year’s estimated tax liability.
Information Needed to Estimate Tax Payments
Those who opt for the do-it-yourself approach must know their adjusted gross income for the previous tax year. They must then estimate their total income for the current tax year. This figure must include investment income and other sources of taxable income that are above and beyond any self-employment earnings.
Next, individuals must estimate their total deductions, exemptions, and credits. They must factor in both the self-employment tax (the additional Social Security and Medicare taxes they must pay, in lieu of an employer paying on their behalf), as well as the tax deductions for the self-employment tax.
How to Determine Estimated Tax Payments
Armed with the aforementioned information, independent contractors may then determine their estimated tax payments in one of the following two ways:
1) They may make quarterly estimated tax payments totaling 100% of their previous year’s tax liability.
2) They may make quarterly estimated tax payments totaling 90% of the current year’s estimated tax liability.
It is often recommended that self-employed individuals put aside approximately 20% to 30% of their earnings for taxes.
The first approach makes the most sense for individuals who can reliably predict their annual income based on past patterns. This tactic guarantees that an individual will not owe any penalties or interest for underpaying their taxes; however, in some situations, it can mean an individual ends up paying much more tax than they actually owe for the year.
In such a scenario, a taxpayer must wait until the following April to get their money back through a tax refund. This is problematic because such individuals are effectively losing out on interest they could have collected on the money they overpaid had they parked those funds in an interest-bearing investment.
What Are Payroll Taxes?
Payroll taxes are generally considered to be the taxes paid to Social Security and Medicare in the amount of 15.3%. Half of this is paid by you and half of it is paid by your employer. If you are self-employed, you are responsible for the entire amount. Other classifications include federal taxes and state taxes in payroll taxes.
What Is the Deduction for Self-Employment Taxes?
As a self-employed individual, you are responsible to pay 15.3% in Social Security tax and Medicare tax. Typically, half of this would be covered by an employer but self-employed individuals are responsible for the entire amount; however, the employer's portion of the tax (7.65%) can be deducted.
What Happens If You Are Self-Employed Without Pay Stubs?
If you need to show pay stubs for whatever reason but do not have any because you are self-employed, you can show previous years' tax returns, invoices, bank statements, or profit/loss statements.
The Bottom Line
If your employer doesn't withhold payroll taxes, you will have to pay these taxes yourself. This typically applies to independent contractors who need to make quarterly estimates of their taxes to the IRS.
To do this on your own, you will need certain information, such as your adjusted gross income from the previous year, estimated total income for the current year, as well total deductions, exemptions, and credits. It is always worth consulting a tax professional to help you estimate your taxes so you don't get it wrong, which may result in fees and penalties with the IRS.