Independent worker tax question

September 6, 2008 7:24 AM

My wife starts a new contracting job next week. I am looking for a good calculator to formulate how much should be set aside for taxes. I've Googled with no good solution. Is there a formula you use? If you are an independent contractor do you have any tips?
posted by Macboy to work & money (13 comments total)

My father, wife and sister-in-law, all independent contractors of one sort or another, generally did 40% in the bank for the first few months until they had better estimates of what they'd be making. It was harder for my father because he was consulting and the work was irregular - big money one week, then nothing for a while. I assume she also knows (more than I can relate) about estimating taxes and scheduling quarterly payments toavoid failure to withhold penalties and hassles. In general, I also assume she's anticipating much more complex taxes than when she was an employee. She'll get charged at a much higher rate and need to chip away at it with deductions and expenses and should get better advice on the specifics of that than you can probably find on MeFi. We ended up getting an accountant because the fees she charged were a lot less than the value of the hundreds of hours we'd have had to spend teaching ourselves the minutiae of tax law.
posted by el_lupino at 7:38 AM on September 6

I would (and did at one time) take the highest federal rate and add to that my state rate and hold that back. Or, conservatively 50%.
posted by JohnnyGunn at 7:47 AM on September 6

As above: 40-50%. 40% is more accurate with reasonable deductions 50% is a nice round number that let's you have extra to stick into retirement (for that deduction!)
posted by Wink Ricketts at 7:51 AM on September 6

40% is a good rule of thumb, but it's liable to vary widely, depending especially on the state in which you live (i.e., is there a state income tax?) and the nature of the work (i.e., will there be lots of deductible expenses?).

Will she be working set number of hours per week/month (that is, will the pay be relatively constant over time), or may it vary? If you can estimate how much she'll make this year, just figure out the difference between what y'all make without the gig, and then with it. Then adjust for the estimated amount of deductible expenses she'll incur.

Then look up the appropriate amounts in the IRS 1040 tax tables -- that will be the extra federal tax for which you'll be liable.

Then do the same for your state, if you have a state income tax.

Then calculate 15.3% of that for your federal self-employment tax.

Add them all up, and you'll have a pretty good sense of your extra tax liability for the year, and therefore a rough estimate of how much to set aside for taxes.
posted by Doofus Magoo at 7:55 AM on September 6

I'm in South Carolina. Yes we have a state income tax and hurricanes.
posted by Macboy at 8:11 AM on September 6

I did 5 years as an independent contractor and held back 35%. Sometimes I owed, sometimes I didn't. So I'm nthing 40%. I also nth religiously making quarterly estimated tax payments and getting an accountant. Both of those will bring a lot of peace of mind to what can be an uncertain circumstance.
posted by ImproviseOrDie at 8:20 AM on September 6

IRS Form 1040ES. It has a worksheet in it. You have to have some underlying idea about how much money you'll be making, but just run through it with a few estimates at your adjusted gross, figure out the highest end percentage that could be required of you and use that.

ie, go though the worksheet with the highest amount that you think is probable, come up with some % (say, 42%) and retain that.


Remember to pay your quarterlies!
posted by a robot made out of meat at 8:49 AM on September 6

I'm a consultant with a widely variable income, and you can learn from my mistake. I track my money using Quicken. The first year, at each quarter, I asked Quicken how much I had made so far that year. I projected that amount onto the entire year and figured the tax using Quicken, but Quicken assumed I was an employee. I paid 1/4 of the tax Quicken told me, but that didn't include the SE tax, so I had to write a bigger check on April 15 than I was prepared for. So if you use a calculator, make sure it includes the SE tax. There are several online calculators for that.

After the first year, it's relatively simple. Here's what I do:

1. Every time a client pays an invoice, I immediately put a certain percentage in a high-interest ING Direct savings account called "tax." If you're just starting out, 40% is probably safe.

2. Each quarter, I send the IRS a check for 1/4 of the tax that I owed last year.

The minimum amount you're required to pay through estimated payments is 100% of last year's tax or 90% of what you'll owe for this year, whichever is less. Since my income tends to increase each year, I go with the first figure and let the excess pay me interest in my ING account until April 15. This is with my accountant's blessing.

If you don't already use money-tracking software, this is a good time to start, because deductions are going to be a lot more important.

Don't forget to track mileage--it adds up fast. 2008 rates from this IRS site:

* 50½ cents a mile for all business miles driven,
* 19 cents a mile for the use of your car for medical reasons,
* 19 cents a mile for the use of your car for a deductible move, and
* 14 cents a mile for the use of your car for charitable reasons.

I recommend the Nolo book Deduct It, which easily paid for itself.
posted by PatoPata at 9:10 AM on September 6 [1 favorite]

It really depends on the type of job but I find 40% to be very conservative. I find that if you make roughly around the median current income (which is something like 51k), holding 33% for taxes is more than fine. However, make sure that you pay your estimated quarterly taxes or your will be penalized quite a bit of money.
posted by Stynxno at 10:11 AM on September 6

Remember to pay your quarterlies!

These payments are due beginning in the 2nd (consecutive) year of receiving self employment income, as stated by PatoPata here:

2. Each quarter, I send the IRS a check for 1/4 of the tax that I owed last year.

Starting out, your first year you get a safe-harbor since your SE income from the previous year was $0.

I recommend creating a spreadsheet that calculates your 2008 tax liability to the penny.

You're going to need to get a Schedule C going, and a Schedule SE, and then a Form 1040.

It's not that hard; you've got:

1) Income
2) Deductions to income like capital purchases (within the limit), expenses, and the home office deduction (if taken)

1) - 2) gives you net income which is taxed via the SE Tax at 13.5% (but you get half of the SE tax back as a deduction, so the net SE Tax rate is closer to 10%).

3) then there's the 1040-level stuff of exemptions, standard deductions and/or another things like home mortgage interest deduction.

I do my taxes manually via my spreadsheeting but do the actual data entry and whatnot via TurboTax to check my work and simplify the filing process.
posted by troy at 11:27 AM on September 6

^ SE Tax at 13.5%

15.3%, as stated above.

15.3% x 50% x 25% marginal rate is a 2% rate reduction via the deductibility of the SE tax, for a net effective SE tax rate of ~13%.
posted by troy at 11:32 AM on September 6

I use the services of a "pass through" company to whom I'm a 'W-2' employee of. I bring the contracts and for 5% they handle all the paper, stay out of my way, and allow me to realize many deductions on a weekly level. I get to pay for tuition, transportation costs, and all medical expenses (including premiums) tax free. The also offer group health insurance and a fantastic 401(k) plan.
posted by khedron at 9:19 PM on September 6

Minor correction; the mileage rate increased as of July 1, 2008 to 58.5 cents per mile.
posted by Doofus Magoo at 4:40 AM on September 8