Independent contractors are considered to be self-employed even if they only work for a single client. Rather than relying on an employer to withhold their payroll taxes for them, they are responsible for paying their own payroll taxes and making quarterly estimated tax payments to the Internal Revenue Service (IRS).
Waiting until the annual tax deadline will get you hit with penalties and interest for late payment.
Independent contractors can 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.
Key Takeaways
- Self-employed people 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 download IRS form 1040ES, along with the accompanying instructions and estimated tax worksheet.
- Quarterly filers can estimate their taxes either by sending the same amount they owed for that quarter in the previous year or by paying at least 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 any other sources of taxable income in addition to 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 all of the above information, independent contractors can then determine their estimated tax payments in one of the following two ways:
1) Make a quarterly estimated tax payment totaling 100% of their previous year’s tax liability for that period.
2) Make a quarterly estimated tax payment totaling 90% of the current year’s estimated tax liability.
Tax professionals recommend that self-employed individuals put aside 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 the past. It guarantees that the person will not owe penalties or interest for underpayment. It can, however, mean accidentally paying more tax than is actually owed.
Anyone who overpays must wait until after the following year's April deadline for annual tax returns to get their money back through a tax refund.
What Are Payroll Taxes?
Payroll taxes are generally defined as the amounts labeled FICA and MEDFICA on a pay stub.
FICA translates as the Federal Insurance Contributions Act and reflects the employee's payment towards future Social Security retirement benefits. MEDFICA, or the Medicare Federal Insurance Contributions Act, is the amount that goes towards health insurance for retirees.
The tax rates for FICA and MEDFICA add up to 15.3%, half paid by the employee and half by the employer. Self-employed people are responsible for the entire amount although the employer's share is deductible.
Of course, federal income taxes and (for most Americans) state income taxes also are withheld from employees' paychecks. Self-employed people make estimated quarterly payments for these taxes as well.
What Is the Deduction for Self-Employment Taxes?
As a self-employed individual, you are responsible for paying 15.3% in Social Security tax and Medicare tax. Half of that amount is the employer's share.
The employer's portion of the tax, or 7.65%, is deductible.
What Happens If You Are Self-Employed and Have No Pay Stubs?
If you're self-employed you won't have any pay stubs but you should have records of your income and expenses in some form. You can show previous years' tax returns, invoices, bank statements, or profit/loss statements. The IRS doesn't want to see them unless you're audited.
The Bottom Line
If your employer doesn't withhold payroll taxes, you will have to pay these taxes yourself. This mostly 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, your estimated total income for the current year, and records of any deductions, exemptions, and credits you expect to be eligible to take.
