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 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 estimated tax worksheet.

Key Takeaways

  • 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.

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 is 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.

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.

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 he or she actually owes for the year. In such a scenario, a taxpayer must wait until the following April to get his or her 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.