Form 1040 is where you’ll report your income and deductions for the year, so you can calculate how much income tax you owe. This is completed at year-end and is due on April 15.
Why are quarterly tax forms due on January 15 and your 1040 due on April 15? This is because the 1040 is much more in-depth with its deductions and calculates the official amount of tax you owe for the year. Your quarterly taxes are just estimates so the government can collect cash throughout the year. (Remember: The government’s “income” comes from taxes. Imagine if your company only paid you once a year—you’d probably be in financial trouble.)
Some expenses you have as an independent contractor will go on the 1040 instead of on your Schedule C. For example, if you pay for your own health insurance and aren’t eligible for a spousal or employer-sponsored plan, you’ll be able to claim that as an above-the-line deduction on your 1040.
Preparing Self-Employed Quarterly Taxes
If you’ve been an employee before, you know your employer withholds taxes from your pay before you receive a paycheck. They then send those taxes to the government on your behalf on a monthly basis. As a contractor, taxes aren’t withheld from your pay; however, the government still wants to get paid throughout the year, so they require you to send in your own quarterly taxes with Form 1040-ES (discussed above).
Most independent contractors have to pay quarterly taxes. The easiest way to tell is with the $1,000 test:
- If you expect to owe more than $1,000, you’ll probably have to pay quarterly taxes.
- If you expect to owe less than $1,000, you probably won’t have to pay quarterly taxes, but you will have to pay year-end taxes.
In both cases, you’ll calculate your final official tax payment when you do your year-end taxes. Depending on how much you paid throughout the year, you might over or underpay. But what happens then?
- If you overpaid on quarterly taxes, you’ll get a refund at the end of the year.
- If you underpaid on quarterly taxes, you’ll pay the difference at the end of the year, plus penalties and interest.
You only owe taxes on your business profit, which is business earnings minus business expenses. Make sure you’re keeping good track of these, since if you don’t track your business expenses, you’re losing money to taxes you can’t get back.
In most cases, if you underpay your taxes throughout the year, you’ll be subject to fines and penalties at the end of the year. These can be as much as 10% for federal, plus another 10% for your state. So if you owed $5,000 in federal taxes and $1,000 in state taxes and didn’t pay throughout the year, you could owe up to $600 in additional fines and penalties.
Preparing Self-Employed Year-End Taxes
On an annual basis, you’ll calculate your final taxes for the prior year. If you owe less than you paid in quarterly tax payments, you’ll get a refund; if you owe more than you paid in quarterly taxes, you’ll owe more money to the government. You’ll fill out a Schedule SE to calculate your self-employment taxes, plus Form 1040 to calculate your federal income tax. You may also need to calculate state or local income taxes.
Understanding the Self-Employment Tax
As previously mentioned, part of everyone’s income goes towards supporting Social Security and Medicare. This is called the “FICA tax” if you’re an employee or “SECA tax” if self-employed. When you are an employee, you pay about 7.5%, and your employer pays another 7.5% for you. When you’re self-employed, you pay the full 15% (actually 15.3%) yourself, hence why it’s nicknamed the “self-employment tax.”
For contractors, your self-employment tax is calculated on a Schedule SE (SE stands for self-employment). After you calculate your net profit on your Schedule C (your earnings minus expenses), you’ll then calculate how much of that is subject to self-employment tax.
The tax is used to fund the nation’s Social Security and Medicare programs. These are programs that take care of you after you retire or if you become permanently disabled. As mentioned earlier, all wage earnings in the U.S. must contribute to these programs.
Now that you understand that you must file taxes on income as you earn it, as well as contribute an extra portion for your part of Social Security and Medicare, you can better prepare for the tax-filing season.
This will help ensure you don’t have to pay additional fees or penalties for underpaying your taxes and can keep more of your hard-earned money. Use this self-employment tax guide in conjunction with accounting software to accurately track your expenses and income, calculate your quarterly taxes and have a smooth tax-filing experience. For more tax-time tips, see our articles on avoiding an audit and filing taxes when you have both 1099 and W-2 income.