“A dream doesn’t become a reality through magic; it takes sweat, determination and hard work.”-Colin Powell. The advantages of self-employment are having control, freedom and independence. However, it comes with different responsibilities, such as paying taxes.
A self-employed individual that has a business as a sole proprietor or an independent contractor; member of a partnership; and someone that has a part-time business. When you are self-employed, no one is withholding taxes from your income. Thus, the Internal Revenue Service requires that self-employed individuals pay self-employment taxes and federal income taxes. Self-employment taxes are Social Security and Medicare taxes. When you are a wage earner, Social Security and Medicare taxes and income taxes are withheld.
When you are a wage earner, your employer withholds federal income tax, Social Security, and Medical taxes from your paycheck. As a self-employed individual, you are responsible for making estimated tax payments on a quarterly basis to pay your self-employment taxes and income tax. If you are a sole proprietor, you are required to make estimated tax payments if you are expected to have a tax liability of $1,000 or more when filing a tax return. If you are a partner, Corporation, or S-Corporation Shareholder, you are required to make estimated tax payments if you are expected to have at least a $500 tax liability. To determine your estimated tax, you can use your previous year tax return to figure out your tax liability, take the tax liability from the previous year tax return and divide that amount into four (quarterly) payment periods. Failure to make estimated tax payments can result in penalties.
What happens when you are a full-time employee and have a part-time business as an independent contractor? When you are an independent contractor, you will receive Form 1099-Misc from the company that you contracted with. Contractors do not withhold taxes from independent contractor’s income. You are responsible for paying self-employment taxes on your 1099 earnings (independent contractor’s income) and your income tax is based on your 1099 and wage-earned income. The advantage of an independent contractor is that you’re able to deduct your reasonable and necessary expenses associated with your services/business, which will reduce your self-employment taxes and income tax.
There are several ways to pay taxes on your 1099 income: (1) withhold more taxes from your full-time job by completing a new Form W-4 to reduce the amount of exemptions; (2) make estimated tax payments; or (3) pay a penalty at the end of the year for failure to pay estimated tax payments or adjusting Form W-4.
Author: Sakinah L. Tillman, Esq., LL.M
Managing Member of Tillman Tax Services, LLC.
(Image credit: money.howstuffworks.com)