Saving for Taxes if You’re Non-W2 Employed
Whether “Non-W2 Employed” means you get a 1099 form for independent contractor work or you don’t get any kind of form because you’re self-employed, you still have to worry about taxes. Because you don’t have an employer taking taxes out for you, you have to figure out how to pay them yourself.
Determining Your Tax Bracket
Taxes can be complicated. My hope is to simplify this explanation as much as possible.
How much you make, and how you file (single, married filing jointly, married filing separately), will determine your tax bracket. The federal government taxes your income, as do (most) states. In order to determine what percentage of your income your federal and state (and possibly local) governments want from you each year, you have to let the internet do a little math for you.
Don’t worry, it’ll be mostly painless. I promise.
Federal Income Tax Bracket
The IRS breaks it down for you on their website (except I can’t find the page at the moment), but I found a really great calculator that does all the math for you, which is even better.
Personal Example: Knowing that my husband and I file jointly, and his salaried wage is $35,000 a year and mine is around $25,000 (between working for myself and working at my job), I used the tax bracket calculator I mentioned above to figure that the tax bracket on our combined $60,000 a year is 15%.
If I was single and making $25,000 a year, my tax bracket would be 15% as well, but if my husband was single, the tax bracket for his $35,000 a year would be 25%.
It’s a fun little calculator, if you like that sort of thing. ^_^
Determining Your State Tax Bracket
In addition to Federal Income Tax, you also have to think about the Income Tax imposed by your state (and possibly your county/city/town). This varies, of course, from state to state, but I found a great calculator for this too: TaxRate.com/StateTaxCalculaor
Personal Example: I currently live in Colorado, and make $25,000 a year. Because Colorado taxes by state, county, city, AND county district, it seems a little complicated, but the bottom line is my state tax bracket is 8.06%. (See the calculator above, because even I don’t necessarily want to do this math.)
When I lived in Michigan, they only tax at the state level, which for $25,000 is 6%.
Put together, my total income tax is 23.06%.
In any case, once you know what your tax bracket is, you know how much you have to save.
Saving to Pay Your Taxes
So, let’s pretend that you make $16,000 a year (that’s $8.00, 40 hours a week, 50 weeks a year), which puts you in the 15% federal tax bracket. And just for laughs, let’s assume you have to pay 7% at the state/local level for that income level.
That means that every time you get paid, via personal check, or cash, or paypal (or whatever), you need to take 22% of that income, and put it in a savings account. And if you want to make your life easier, you could just save 25%. It’s never bad to save more than you need.
As for where to save it, I like the online savings accounts at ING Direct because they earn more than 1% interest, but the savings account at your bank is just fine if it means you’ll start savings now instead of tomorrow or next week.
Paying Taxes When the Times Comes
You’re dutifully putting 22% (or 25%, or whatever percent) of your income in savings each time you get a paycheck, and you’re watching the balance grow (which is exiting). Between now and April 15th, you just have leave the money there. Really, it’s your safety net.
Then, once you file your taxes, the government will let you know how much you owe them (which could be a lot if you worked almost exclusively for yourself or as an independent contractor) and then you will be very glad you saved all that money.
A (sort of) Personal Example: My step-brother, who works as a server, found out last year that he owed the government almost $2,000. I don’t know all the details of why he owed so much money, but he had no idea that he was going to owe anything either and therefore hadn’t saved. When he got his notice from the government, he was scrambling to pay it by the deadline, and ended up borrowing money from his father, whom he is now repaying.
If You’re Self-Employed
Those of you (us?) who are self-employed (i.e., no one takes any money out of your income for taxes), and make a bulk of your living that way, you should definitely also be paying the Self-Employment Tax.
The Self-Employment Tax rate is currently at 15.3% and covers your portion of Social Security and Medicare. If you were employed by someone, they would take this out of your paychecks each month, but since you employ yourself, you’ve got to do it.
That means that instead of saving 25% of your earnings (adjusted of course for your personal tax bracket), you’d have to save 40%. That seems like an awful lot, and it is. And there is a chance that you won’t owe the government nearly that much, so you might be tempted just to spend the money and deal with what you do owe when the time comes, but you’re much, much better off having the money and not needing it, than needing it and not having it.
Estimated Taxes and Quarterly Payments
I could also get into making quarterly payments of your estimated taxes to the government, but that likely applies to only a few of you, and I’m not sure I entirely understand it. I’ve never had a year where I’ve made even a quarter of my income from independent contract work / self-employed work (although I’m hoping that will change) so I’ve never had to figure it out. But if anyone wants to know, and doesn’t want to do the research, let me know and I’ll be happy to figure it out.