People generally become independent contractors because they want to be able to control their schedules, time, and projects. But how do you handle it if they come to you and ask how they calculate their net pay because no taxes have been taken from their contracted fees? If an independent contractor comes to you questioning their correct tax responsibilities:
When you think about this challenge, recognize that this conversation can put you and your company in a challenging position. Unless you are in the business of providing tax advice, you don’t want to give the perception that you are qualified to provide it. Even so, let’s look at some basics that independent contractors need to know.
When someone decides to become an independent contractor, they often are focused on the upsides of the prospect. Few understand that they are responsible for paying not only the employee portion of Medicare and Social Security tax, but also for the employer’s. According to the IRS, the 2022 combined deductions are 15.3%, and the deduction rates cap out at $147,000 and are calculated at:
There is a caveat. When the contractor’s annual income exceeds $200,000 or more ($250,000 if married and filing jointly, or if filing separately, but married, $125,000), the Medicare tax incurs an additional .9% on everything earned about that amount.
There’s much more, but a tax advisor could get to the bottom of a comprehensive list.
Before an independent contractor can determine what income number to use for their Medicare and Social Security tax calculation, they first need to figure out their business’s net profit or net loss.
Even so, say this driver started off with a first-quarter (January 1 – March 31) income of $7,200. But then, when the legitimate deductions were applied, found that the actual taxable income was $6,480. What would that mean aside from the fact that they found $720 in deductions? Remember … there’s also the Federal personal deduction! The site says that:
So, $19,400 ÷ 4 = another $4,850 in quarterly deductions. Now the first quarter’s projected taxable income is $1,630. Now, let’s look at the numbers.
Continuing on with our driver example, if this contractor made $1,630, after deductions, in the first quarter of the year, they would be responsible for:
This is not the same as the contractor’s income tax, though. Income tax is calculated based on the projected annualized income at the Federal level and various rates at local and state levels. In keeping with the same example, this contractor’s projected annualized taxable income would be approximately $6,520. According to the IRS’s 2022 tax table, the federal rate for an individual is:
So that would be an additional $163 for the first quarter’s projected Federal income tax. This is where it starts to become clear that having a plan to save for quarterly tax payments is critical. So far, without considering state or local income taxes, the contractor’s estimated quarterly tax bill is:
If this particular contractor decides to set aside $68.75 on the 15th and the last day of each month, they will have their tax savings ready. They won’t have any headaches on filing day.
In today’s environment, your company will likely work with professionals who are new to being independent contractors. Be proactive. We have provided you a high-level understanding of what the contractor needs to be prepared to pay. Still, we also suggest that you create a resource sheet that has:
This will let you be helpful and seen as a great partner without placing you or your company at risk of giving tax advice.