When it comes to paying taxes, working for yourself (as opposed to working as an hourly or salaried employee for a company) can be a bit tricky. When you’re hired as an employee, you fill out a W-4 form (which is also known as the Employee’s Withholding Allowance Certificate) and the information you provide on that form helps calculate the amount of taxes that are withheld from your paycheck.
This form includes spaces for you to add your name, address, filing status (i.e., single, married filing separately or married but withholding a higher Single rate), and the number of allowances you are claiming. If you’re single and you don’t have any children, you can claim one allowance for yourself, and a second if you only have one job. If you’re married but your spouse doesn’t work (or they make less than $1,500 per year), you claim one allowance for yourself, one for your spouse, and a third if you only have one job. The more allowances you claim, the less taxes you’ll have withheld from your paycheck.
Your employer will also withhold taxes to cover 6.2% of your income for Social Security taxes and 1.45% of your income for Medicare taxes. Your employer will also match what you pay in Social Security and Medicare taxes. Why? Because the total Social Security and Medicare tax rates are 12.4% and 2.9%, respectively.
At this point, you might be wondering why any of this is important.
Independent contractors must pay their Social Security and Medicare taxes on their own
Imagine that Jane Smith is a graphics designer who has worked for a large company for all of her life, but in the past 12 months, she’s decided she wanted to branch out on her own. Since she’s never worked as a 1099 independent contractor before, she wasn’t sure how much money she should be setting aside for her taxes. Let’s also imagine that she calculated what she’d owe based on last year’s tax return (which she filed when she was still with her former employer.)
Suffice to say, the next time Jane files her taxes, she’s going to be quite surprised that she didn’t plan correctly. When you don’t plan IC taxes correctly, not only do you run the risk of being hit with a large, unexpected tax bill, you could find out the IRS is charging you a penalty, because you didn’t pay your taxes in quarterly installments.
If you’re thinking about working as an independent contractor, you’ll want to understand how you’ll be taxed. You’ll also want to talk to a certified tax professional to find out how quarterly taxes work, why you need to pay them, and the ramifications you could face if you don’t. For more information on how independent contractor taxes work, call our office today to speak with an expert.