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How To Calculate Tax Withholdings For Independent Contractors

Working as an independent contractor is different from working for an employer in a lot of ways. If you're working for yourself, you're probably enjoying being your own boss and having control over when and how you work.

What you're probably not enjoying are the tax aspects, which involve more work than they do when you're an employee of a company. When you are a W-2 employee, companies automatically take money out of your paycheck, or withhold it, to pay for Social Security and Medicare taxes. These are called self-employment taxes if you're, well, self-employed. Companies also withhold income tax.

And if you're self-employed, an independent contractor, a freelancer, a gig worker, etc., it's on you to pay those taxes. The self-employment taxes, also called SECA taxes, independent contractor taxes or withholding taxes, must be paid quarterly, or four times throughout the year. That means you need to set aside money to be able to pay them.

To make sure you're ready when the quarterly deadlines hit, you'll have to know how to calculate independent contractor taxes and make sure you're ready.

What is independent contractors tax?

For W-2 employees, the cost of SECA taxes is split between the employer and the employee. But independent contractors are responsible for both halves.

Independent contractors taxes fund both Medicare and Social Security, two social programs designed to benefit older Americans (and you someday) as they age out of the workforce or get injured and can't work. Medicare provides health insurance for these same older or injured Americans.

The bill for both totals 15.3% of what every freelance worker makes, minus their tax deductions. 12.4% of it goes to pay for Social Security, with the second 2.9% going to fund Medicare. Since you don't work for a company, which would pay half of that (7.65%), you're on the hook for the full 15.3%.

But, even with taxes, there's sometimes a bright side: you can take half of your self-employment tax as a deduction from your income taxes.

What does this look like if, for example, you're a carpenter who made $140,000 finishing three basements, building a couple of decks and making all the cabinetry for a company's breakroom last year? You would have had to pay the IRS $21,420 in self-employment taxes.

$17,360 would have gone toward Social Security. There is a limit on this that changes every year, but you wouldn't have come close to it. The most a person can pay in Social Security is $142,800.

For Medicare, you would have had to pay $4,060 on your $140,000, and there's no limit to this portion.

How to calculate withholding tax

Obviously, you can't save what you need to pay your quarterly estimated taxes (which are made up of self-employment tax and income tax) unless you know how much you will be required to pay. Thankfully, figuring that out is relatively easy. The first step is to know how much you've made.

Quarterly estimated taxes are also known as withholding tax, because you will want to withhold them from your income in order to pay your quarterly taxes. Figure out the amount of your net earnings, which is every dollar you've brought in, minus any business expenses that you can deduct from your taxable income.

You'll want to take into account your withholding and refundable credits, or the amount of quarterly taxes you paid and any tax credits you can take advantage of, at the end of the year when you fill out your 1040. Then you apply that 15.3% to your net income.

In a perfect world, you have a way of knowing every business expense that can be deducted from your taxable income, and you're able to lower your tax payment by a healthy amount. Say you found $30,000 worth of deductions, and you subtract that from your $140,000 total income to get $110,000 of taxable income.

Just apply that 15.3% tax rate to the $110,000, and you would be liable to pay $16,830 to the IRS in SECA taxes, half of which you can deduct from your taxable income when you're figuring out how much income tax you owe.

So, you'll want to set aside at least $8,415 to pay self-employed taxes as an independent contractor.

When to pay self-employment taxes

Taxes for independent contractors are paid on a rolling basis. You'll have to estimate what you owe each quarter and pay that amount to the IRS. Speaking of the IRS, they say if you pay 90% of what you owed in taxes last year, you'll be safe.

That's if your adjusted gross income, after you've taken all your deductions, was $150,000 or less. If it was above $150,000, you'll need to pay 110% of that amount in quarterly estimated taxes.

Penalties for missing a quarterly tax payment

If you forget to make a quarterly estimated tax payment, the IRS will send you a notice indicating that you'll need to pay a penalty. It consists of an additional 0.5% of the balance you owe each month after the missed deadline, until you reach the maximum 25% of the amount you owe.

There are ways to remedy this situation, such as paying what you can, even if it's not the full amount, to show the IRS that your intentions are good. Then you can reach out to them to set up a payment plan to make payment easier on you.

Quarterly tax and self-employment tax calculators

FlyFin has developed the world's most accurate quarterly tax calculator, taking into account your income and deductions and giving independent contractors the ability to confidently and accurately calculate, rather than estimate, their quarterly tax payments – and avoid quarterly tax penalties.

Another invaluable tax calculation tool gives you an accurate payment amount based on the current self-employment tax rate, so never need to wonder if you're paying the right amount for Social Security and Medicare, as well as income taxes.

FlyFin CPA Team

FlyFin CPA Team

With a combined 150 years of experience, FlyFin's CPA tax team includes tax CPAs, IRS Enrolled Agents and other tax professionals, offering users the most comprehensive tax advice and preparation.

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