Paying estimated tax for self employed contractor / consultant?

Question

Up until this year (2007), I was employed by a company and they withheld my taxes. I've always withheld enough and usually got a tax refund each year.

Starting Jan 1, 2007 this year, I switched to a self employed contractor status. The employer paid me gross amount each month with no withholding.

Since I had no penalties or tax underpayment in the past, I was not required to pay estimated quarterly tax payments this year.

My question is: I know I will have to make a big tax payment on April 15, 2008 since I didn't have any withholding and didn't make any estimated tax payments this year.

Should I make a big estimated tax payment this month before the end of the year, or would I get charged interest/penalty anyway for not making payments earlier this year in prior quarters?

Answer 1

Sorry, but you WERE required to make estimated payments this year. To avoid any penalties for underpayment of 2007 taxes you must have paid in an amount at least equal to your 2006 total tax liability. Those payments were due on 4/18/2007, 6/30/2007, 9/17/2007 and a final paymet is due on 1/15/2008. The only way you could avoid penalties under the 100% rule would be if your tax liability for 2006 was $0. Not being penalized in the past does NOT get you a bye for 2007.

You could pay in 3/4 of it now using the 3rd payment coupon on Form 1040-ES (that was due in September) and the final 1/4 in January and cross your fingers that the IRS doesn't catch it, but don't hold your breath. If you can substantiate that your income was cyclic and most of it was actually earned near the end of the year that would work but if it was spread out more or less evenly throughout the year it probably won't.

The sooner you make any payments, the less the penalties will be, so I'd pay as much as possible right now and hope for the best but prepare for the worst.

Answer 2

Was there any change in your duties when you became a self employed contractor or are you being cheated out of benefits by your employer?

I have a canned explanation I post constantly for apparently clueless independent contractors:

Some employers try to get around paying employment taxes (social security and unemployment) and other employee benefits like workers compensation insurance by improperly classifying employees as independent contractors. The basic issue is the amount of control the employer has over the worker. If you are required to show up for work--personally--at a particular time, punch the clock, use the employer’s equipment and are paid an hourly rate, or another set rate based on time served, you are an employee. If you didn't understand the difference when you posed your question, I would be even more convinced that you are an employee. What is your preference, Slotted or Phillips? Complete an IRS Form SS-8 to get an official ruling on your status. This will help you get unemployment if you get fired. When you file your income tax return, you can attach Form 8919 Uncollected Social Security and Medicare Tax on Wages and only pay the employee's half of social security. You will still have to cough up all the income tax. IRS and the states are stepping up enforcement in this abuse area.

Answer 3

Let's see, 40% of $30,000 is already $12,000. And that's just for federal. If you earned that money evenly during the year and didn't send any estimated tax payments, you could be looking at a $500 penalty for failing to do so (8% of $12,000 on a weighted average). You still have time to increase the withholding on your W-2 and send in the 9/15 payments (it's late for 4/15, 6/15 and 9/15). If you can't pay the tax bill at tax time, you will end up on an IRS payment plan. Unless you screw up that agreement, you will owe roughly 12% for penalties and interest. PS, are you covered on a retirement plan at work? There is a partial IRA deduction if your income is above $83,000 for the year. If you make $90,000, you may only be able to deduct $2600.

Answer 4

You must pay estimated tax for 2007 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2007 after subtracting your withholding and credits.

2. You expect your withholding and credits to be less than the smaller of:
*90% of the tax to be shown on your 2007 tax return, or
*100% of the tax shown on your 2006 tax return. (110% if your AGI is more than $150,000 or $75,000 for married filing separately). Your 2006 tax return must cover all 12 months. (Source IRS Publication 17: Your Individual Income Tax).