Independent contractors have it rough when it comes to handling taxes. While the rest of the working world has income deducted from each paycheck to cover taxes, the independent contractor is forced to figure everything out on their own.
Figuring out your own taxes can feel like working on a complicated math problem. When you get the problem right, you have the pleasure of forking over your money. When you get the math problem wrong, it means penalties, or worse.
In this article, we take a look at how independent contractors can get their quarterly taxes right.
Independent contractors are disadvantaged from a tax perspective in several ways.
- Withholdings: People with consistent employers have money withheld from each paycheck that goes directly to paying taxes. When taxes are due the withholdings usually will have covered all or most of the money they owe to the government. This usually does not happen for independent contractors. They have to figure out what to pay independently.
- Inconsistency: Independent contractors also don’t make money with the same consistency that salaried employees do. One month might be very busy, while the next could be very slow. This is particularly true for independent contractors whose jobs have a seasonal aspect. For example, a landscaper may have lots to do in the spring and summer, but not very much work at all in the fall and winter.
- Understanding: Finally, understanding. Just because you are good at landscaping, construction, or writing doesn’t mean you know the ins and outs of tax law. Many independent contractors find themselves on the wrong end of tax fees for the simple reason that they didn’t know they were breaking the rules.
Daunting though it is to be completely responsible for your own taxes, most independent contractors figure out how to do it relatively quickly.
The IRS expects any independent contractor who will owe $1,000 or more in taxes after deductions to make quarterly payments—which accounts for annual earnings of $12,000 or so a year. The math becomes further complicated when you factor in state taxes as well.
The bottom line, however, is that if you are making your living as an independent contractor, the chances are good that you will be expected to pay quarterly.
Developing a Tax Planning Strategy That Fits Your Needs
The punishment for not filing your taxes on time as an independent contractor can be stiff. The IRS expects self-employed workers to pay on a quarterly schedule based on income estimates. This can be established either by taking a look at previous years’ records or by making an educated guess regarding what you will make for the current tax year.
But this is my first year on the job. How can I make an educated guess?
Yeah. That’s the rub. There are several ways you can make an educated guess. Speaking with an accountant is probably the best first step. They will look at your current earnings for the year, ask you some questions, and then help you develop a tax planning strategy that includes due dates and estimates for what you should pay each quarter.
It’s better to err on the side of paying too much. While no one likes paying more than they think they have to, it’s better than paying too little because:
- Incorrectly paying your quarterly taxes can result in fines that start at .5% and get capped at 25%. That adds up quickly. And if you pay too much you will get the money back on your tax return.
As you advance in your career as an independent contractor, you will probably find that working out your quarterly payment schedule is simple. Until then, it’s a good idea to take advantage of every resource you can get.
Consider the Services of a Consultant
The more your business grows, the more complicated your tax situation will become. It’s a good problem to have, but also a situation that requires additional consideration. Business analysts can be hired on a freelance basis to look at your books and make recommendations.
Alternatively, the independent contractor with a rapidly growing business may also consider taking classes to learn more about business management. It’s important to understand that the independent contractor is essentially a business owner for a company that has just one employee.
To find long-term success they need to treat their work the same way any business would. Certainly, this includes understanding tax law, but it also involves financial planning, marketing knowledge, and more. The best way to improve your small business is to understand it, both in terms of what you do on the job and based on what goes on behind the scenes.