Looking on taking an internship and this internship pays as an independent contractor. I have no clue how this works, especially with taxes, and I need some help understanding this.
Can any freelancer or independent contractor break this down for me?
🙏🏾
I'll offer some advice.
Normal salaried jobs have you fill out a bunch of paperwork that tell your company how much money to set aside for your taxes. You also opt into healthcare and retirement which come out of your paycheck.
When you work independently none of these things happen or exist.
Essentially, you'll get a full check for the work you do untaxed. No healthcare and no retirement.
This means you're on the hook for managing your own taxes.
Example:
When tax season rolls around, for the first example you may get a refund or you may owe a little. Thats because the entire year you worked, your company was putting some money aside for your taxes based on some paperwork. The IRS already had money that you essentially set aside from them. So they'll give you any extra as a refund or send you a bill if you set aside too little.
In the second example you'll get a bill. A bill for close to 25k. Thats because you haven't paid any taxes at all and you owe the state and federal government.
One other tidbit. You are also required to pay taxes quarterly when you work independently. If you don't you'll also get hit with a fine on top of your bill.
This probably sounds scary and complicated, but here's a pretty good rule of thumb.
For every paycheck you get, set aside 25% for the taxes you'll likely owe. Pay that amount quarterly to the IRS.
Consider hiring an accountant before tax season to help you with taxes. When you work independently you can do a lot with deductions and whatnot that if you don't know about will have you paying more than you need to. This can add up to some massive savings. I've never lost money on paying an accountant.
How would that work, I’m only familiar with yearly exchanges with the IRS.
There's a quarterly estimated tax payment form. This is required if you are going to end up owing over about $1k by the end of the year.
Estimated tax payments are required based on the total amount of tax owed at the end of the year, not based on a particular source of income. Meaning, if the OP has excess tax withheld from previous/concurrent jobs, these quarterly payments might not be necessary.
Honestly, I'm not sure.
This could be something that varies by state. The last year I was independent I got fined for not making quarterly payments. I've not done more independent work to know exactly how.
Personally only have experience with paying taxes after a year and not doing the quarterly payments. I was paid $20/hour, worked about 25 hours a week. I figured I could save enough money come next April instead of sending checks every quarter.
Once I filed I had to owe taxes (as expected) but don't remember being charged a fine for not paying quarterly. The job was in 2017. Not sure if the rules have changed though.
Depending on the amount you owed they may require you to make quarterly estimated payments the next year -- regardless of what you expect to make. You can counter that with some other IRS forms though.
In particular there is one you can file that basically says I have no idea how my money will come in and can't possibly pay 1/4 of it in Q1. This can help avoid any future fines where the IRS will penalize you saying you withheld payment till the end of the year.
You mail them a check along with a 1040-ES. They check what you paid vs what you actually owe annually. Because of this you want to estimate on the low end.
There are three basic categories to think about: federal income tax, federal self-employment tax, and state/local tax.
The most confusing one for contractors is the self-employment tax. Self-employment tax is FICA (Social Security and Medicare) tax for self employed people. As a regular employee, you would see money taken out of your paycheck for Social Security and Medicare. Your employer would pay additional money for your Social Security and Medicare. Since self-employed people are their own employer, the self-employment tax is you paying both sides of this tax. Last I looked, it was about 14%.
Your federal tax bill ends up being your federal income tax PLUS your self employment/FICA tax. If you expect to owe more than about $1k by the end of the year, then you have to submit quarterly estimated tax payments as someone else mentioned. These payments are balanced against your taxes owed at the end of the year, just like you would normally do with your employer withholdings.
Look up IRS Schedule C for deducting business expenses from self-employment income, and look up Schedule SE for the self-employment tax. These are what you will file with your Form 1040 as a person with self-employment income.
It's a 3 month internship at this point so I'm really not certain as to how to go about this the way you've laid it out here.
That's the thing, there's no particular one way to go about it. If you're employed the rest of the year, you can probably just bump up your employer withholdings during that time and not worry about the self-employed months until you file your taxes next year. If you don't know what the rest of the year holds, then you'll want to pay as you go to avoid penalties.
If you're not sure, I'd recommend saving about 1/4 of your salary to cover tax payments and filling out the estimated tax form for whichever quarters apply. Please note that that's a ROUGH estimate and I'm not an accountant.
Congrats on the internship BTW, I forgot to say that before.
As Ryan Latta said.. get an accountant. They are very very much worth it. I've had one for 20 years that does my personal taxes and my business taxes when I freelanced full time. He saved me way more than I paid him.
There are different arrangements too. Some will ding you for every form and question. Some won't. Find one that let's you ask reasonable questions and lets you do some of the easier work with his guidance, saving the hard stuff for him.
It's seriously totally worth the cost.
Another thing to keep in mind when comparing a salary/hourly to 1099/contract income is that, when you are salaried, your employer is paying a portion of your taxes. (I believe it's around half).
So - let's just say the tax rate is 20% -
Of course this is a simplification - but can be helpful to keep in mind when setting freelance rates: you're going to see a lot less of it than if it were salaried income.
If you're working in America, then this might be useful.