Q: I’ve been doing contract publicity work since experiencing a “reduction in force” in January. How do you recommend I handle earnings to avoid tax problems? I’ve never had tax problems, and I don’t need to start any.
Tracey New, Dallas TX
A: First, I’m sorry you lost your job, but it’s great that you are finding work.
This is actually a great question for our times. Many people who have lost their “day” jobs are turning to contract work or becoming consultants, and now are self-employed.
And, I’m afraid many people who work for themselves fail to pay their taxes and, as a result, get into deep trouble with the IRS.
You do not want to get into tax trouble with the IRS.
So, good for you, for trying to make sure you are paying the taxes you owe. I’m going to give you some general information, but I suggest you find a tax professional who is experienced in dealing with self-employed individuals. And, now is a good time to sit down with someone, before the end of the year and before the crush of tax season.
In general, if you are self-employed, you must pay the self-employment tax, which is a Social Security and Medicare tax for individuals who work for themselves. This is much like the Social Security and Medicare taxes your former employer withheld from your pay.
The rate for this tax is 15.3% on self-employment income up to $106,800. If your net earnings are more than $106,800, you pay only the Medicare portion of the Social Security tax.
This tax is divided into two parts–2.9% for Medicare (hospital insurance) and 12.4% for Social Security (old-age, survivors and disability insurance).
The good news is you can deduct half of your self-employment tax in figuring your adjusted gross income.
You also need to know that our federal income tax system is a pay-as-you-go system. When you are a wage earner your employer withholds your taxes. Now that you are working for yourself, you are expected to make estimated tax payments.
According to the IRS, you must pay estimated tax for 2009 if both of the following apply:
- You expect to owe at least $1,000 in tax for 2009 after subtracting your withholding and credits.
- You expect your withholding and credits to be less than the smaller of: 90% of the tax to be shown on your 2009 tax return, or 100% of the tax shown on your 2008 tax return. Your 2008 tax return must cover all 12 months.
For estimated tax purposes, the year is divided into four payment periods. If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty.
To make estimated payments, use the Electronic Federal Tax Payment System. This allows you to make estimated tax payments on the phone or online.
As I said, I highly recommend you hire a tax professional. You can also find a great deal of helpful information about the self-employment tax and making estimated tax payments on the IRS Web site.
(Photo by CarbonNYC)