When you work as an independent contractor, you don't have an employer taking taxes out of your check every week or month. That means you're responsible for your own income tax withholding. Even though you only prepare income taxes once a year, the Internal Revenue Service requires you to estimate what you will owe and pay it in quarterly installments.
Current Year Taxes Method
The Internal Revenue Service won't hit you with any interest or penalties as long as your four equal quarterly estimated payments total at least 90 percent of your tax liability for the current year. For example, if you owe $5,000 in taxes, if you made quarterly payments of $1,125, you'll owe $500 in taxes when you file, but you won't owe any interest or penalties. However, because estimating how much you're going to owe at the end of the year can be difficult, the IRS allows a second method based on your prior year's taxes.
Prior Year's Taxes Method
If you prefer a more reliable method for the minimum estimated payments, you can use the safe harbor based on your prior year's income. For most taxpayers, you're off the hook for interest and penalties if your payments equal or exceed what you owed in taxes for the prior year. For example, if last year you owed $4,000, and you make four estimated payments of $1,000 each, you won't owe interest and penalties even if you end up owing $20,000 in taxes for the year. However, if your adjusted gross income for the prior year exceeds the limits, your estimated payments must equal or exceed 110 percent your your prior year's tax bill. As of publication, those limits are $150,000 unless you're married filing separately, in which case the limit is $75,000.
Estimated Taxes Due
When you're figuring your estimated tax payments for the year, you have to account for self-employment taxes on top of your income taxes. You can estimate your self-employment taxes by multiplying your net independent contractor income by the self-employment tax rates. As of publication, it's 2.9 percent on all your income for the Medicare portion and 12.4 percent on the first $117,000 of income for the Social Security tax. However, the $117,000 figure adjusts for inflation annually, so it usually goes up from year to year.
Uneven Income Exception
If your independent contractor work is seasonal, meaning you make substantially more during certain times of the year, you may be able to make uneven estimated tax payments under the annualized income installment method. Under this method, you make estimated payments for each quarter based on the tax you would owe if that quarter's income was projected out for the entire year. For example, say you own an ice cream stand and you generate most of your income in the summer. Your first quarterly payment would be smaller, because you probably haven't earned much in the first few months, but your second and third quarterly payments would be larger, because that's when you earn the bulk of your income.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."