About to start being an Independent Contractor - Any advice on estimating taxes?

Question

I am a grad student that is about to pick up 10-15 hours of independent contracting work per week. I work and live in Syracuse. I make $19,000 per year (pre-tax) as a grad student, and will make $25/hr as an independent contractor.

The first paycheck for about 18 hours of work is coming next week. I have filed a W9 with the company, of course, and am doing research on how I should calculate the estimated taxes and make the quarterly payments.

Does anyone have any straight forward advice, tips, rules, that I should follow on estimating the taxes I should estimate given my base yearly salary and an assumed $375/wk (15hr/week * $25/hr = $375/week) in the contracting work? Do I need to pay the estimated taxes only for the contracting work? And since the first paycheck is coming in soon, probably before the September 15th cutoff for the 3rd quarterly payment, should I send money in then or wait til the January 15th date?

I'm going over the 1040ES and it's really hard to follow. I was gonna just estimate 33% and hope it's slightly too much and get money back in April.

Thanks.

Answer 1

I agree with your strategy of using a conservative estimate to overpay taxes and get a refund next year.

As a self-employed individual you are responsible for paying self-employment tax (which means paying Social Security and Medicare tax for yourself as both: employee and an employer.)

Current Social Security Rate is 6.2% and Medicare is 1.45%, so your Self-employment tax is 15.3% (7.65%X2)

Assuming you are single, your effective tax rate will be over 10% (portion of your income under $ 9,075), but less than 15% ($9,075-$36,900), so to adopt a conservative approach, let's use the 15% number.

Given Self-employment and Federal Income tax rate estimates, very conservative approach, your estimated tax can be 30% (Self-employment tax plus income tax)

Should you expect much higher compensation, you might move to the 25% tax bracket and adjust this amount to 40%.

Answer 2

It's likely you don't have to make estimated tax payments if this is your first year of contracting (extra income), and your existing salary is already having taxes withheld.

If you look at the 1040-ES:

General Rule

In most cases, you must pay estimated tax for 2014 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2014, after subtracting your withholding and refundable credits.
2. You expect your withholding and refundable credits to be less than the smaller of: a. 90% of the tax to be shown on your 2014 tax return, or b. 100% of the tax shown on your 2013 tax return. Your 2013 tax return must cover all 12 months.

This is easier to understand if you look at the worksheet. Look at line 14b/14c and the associated instructions. 14b is your required annual payment based on last year's tax. 14c is the lesser of that number and 14a, so 14b is your "worst case". 14c is the amount of tax you need to prepay (withholding counts as prepayment).

I'm going to apply this to your situation based on my understanding, because it's not easy to parse:

1. Your withholding + estimated taxes for 2014 needs to be equal to your taxes paid for 2013 (within a certain threshold)
2. You will be making the same salary as you made in 2013, and will thus have taxes withheld for that amount
3. You do not have to make estimated tax payments.

Answer 3

One possibility that I use: I set up an LLC and get paid through that entity. Then I set up a payroll service through Bank of America and set up direct deposit so that it is free. I pay myself at 70% of my hourly rate based on the number of hours I work, and the payroll service does all the calculations for me and sets up the payments to the IRS. Typically money is left over in my business account.

When tax time rolls around, I have a W2 from my LLC and a 1099 from the company I work for. I put the W2 into my personal income, and for the business I enter the revenue on the 1099 and the payroll expenses from paying myself; the left over in the business account is taxed as ordinary income.

Maybe it's overkill, but setting up the LLC makes it possible to (a) set up a solo 401(k) and put up to $51k away tax-free, and (b) I can write off business expenses more easily.