For Gig Economy workers, the key to a stress-free April 15th is to stay on top of income and estimated taxes throughout the year. If you don't, you'll owe penalties in addition to the tax you should have paid.
Traditional workers receiving a W2 may look forward to a hefty federal income tax refund every spring. As recently as 2015, nearly 80 percent of taxpayers got an income tax refund, and the average amount received back from the IRS was about $2,800.
On the other hand, those who are self-employed and don't make quarterly estimated tax payments can find themselves on the hook for both taxes and penalties. And if you fail to report income and are caught, you could face bigger bills and even jail time.
What taxes are assessed on self-employment income?
FICA Taxes – Employers are required to pay Social Security and Medicare taxes of 7.65 percent on all employee wages, while another 7.65 percent is deducted from the employee's gross pay.
However, employers who use independent contractors have no tax obligation toward these workers, and freelancers are required to shoulder the entire 15.3 percent tax burden on all gross wages.
Federal Income Taxes – Self-employed workers are also responsible for the full amount of federal income tax assessed on their adjusted gross income (AGI). Most employees fill out a W4 withholding form to tell their employer how much federal income tax to withhold from each paycheck and send to the IRS, but self-employed workers don't have that option.
Instead, self-employed taxpayers must make quarterly estimated tax payments on or before April 15, June 15, September 15, and January 15 of each tax year. The IRS provides a worksheet that allows you to calculate your estimated tax obligation, although those with irregular incomes (like most freelancers) may find it challenging to determine exactly how much they'll owe in taxes until after December 31.
Failure to pay estimated taxes or to pay the total tax bill owed by April 15 of the following year can lead to fines, fees, and penalties. These amounts are generally based on the total tax owed (and unpaid) for that year.
State and Local Income Taxes – Self-employed workers that live in states and counties that charge an income tax may also be responsible for making estimated tax payments on the same quarterly schedule and under the same basic framework as federal estimated taxes. However, not all states that charge income taxes require these periodic payments, so it can be worthwhile to research this in more depth to find out your obligations under state law.
How can freelance workers maintain tax compliance?
It is crucial to stay on top of your tax obligations – set aside income as it's earned to cover your estimated taxes and always send tax payments each quarter.
