Working for yourself can be rewarding, but it can be complicated and time-consuming from a tax standpoint. Self-employed individuals are subject to the same federal, state and local income taxes as employees, but self-employed individuals face the added burden of the self-employment tax.
When you work as an independent contractor, you should receive a 1099-MISC form from the clients for whom you worked during the previous year. Wait until you receive all your 1099-MISC forms before you file your taxes. Underreporting your income, even inadvertently, could trigger additional taxes and penalties from the IRS.
When you receive non-employee compensation, the IRS considers you to be both the employer and the employee. That means you are subject to both the employer and the employee contribution to Social Security and Medicare. For 2011, the Social Security tax is 4.2 percent for the employee side and 6.2 percent for the employer. The Medicare tax rate is 1.45 percent for both employer and employee, for a total of 2.9 percent.
If you expect your tax bill to be more than $1,000, you may be required to file and pay your taxes four times a year instead of just once. As a self-employed individual, you cannot rely on an employer to withhold taxes from your paycheck, so you need to estimate carefully how much you might owe and pay the tax bill accordingly. You can use tax preparation software to find your quarterly estimated payments, or you can consult with an accountant or tax expert to help make that calculation.
Lowering Your Taxes
As a self-employed individual, you have a number of ways to lower your overall tax bill. You can, for instance, open a retirement plan such as a Simplified Employment Pension (SEP) IRA and use it to put money away for retirement and save on taxes. You also can open a health savings account and get additional tax savings. A health savings account also helps you defray the cost of medical care, which can be substantial for self-employed individuals. Consider consulting with an accountant or other tax professional to determine which actions will yield the greatest tax savings.