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 use this explanation to simplify them for you 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: TaxFormCalculator.com/State_Tax. After you click the link, you can either choose your state from the left-hand column on the page and then enter your annual taxable income, or you can find your state and click the number in your state’s row that is close to your annual income. You have to scroll down to see the results after you hit calculate, but there is a lot of information packed into the calculator results, including your daily, weekly, and monthly income amounts, and your federal tax rate.
Personal Example: I currently live in Colorado, and make $25,000 a year. According to the calculator, my state tax is 4.63%. But, because Colorado taxes by state, county, city, AND county district, my actual tax rate will be more than that (Around 5.8%). If you live in a state that also has county, city, or local tax, you should google your state’s Department of Revenue and they should be able to offer guidance on what your various tax rates should be.
When I lived in Michigan, they only tax at the state level, which for $25,000 is 4.25%.
Put together, my total income tax is 20.8%.
In any case, once you know what your tax bracket is, you know how much you have to save. (Note: I often round up to the nearest percent when doing my savings calculation. So I would save 21% instead of 20.8%, just in case. I, however, don’t mind getting money back from the government, as long as it’s not an excessive amount.)
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 6% 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 21% of that income, and put it in a savings account. If you didn’t want to futz with odd percents, 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 Capital One 360 because they earn more than 0.7% interest and it take a few days to transfer the money fro there to my regular bank account, so I’m less tempted to use the money for something other than taxes. However, an account at Capital One 360 does take a few days to set up, so the savings account at your bank is just fine if it means you’ll start savings now instead of next week.
So by now you’re dutifully putting 21% (or 25%, or whatever percent) of your income in savings each time you get a paycheck, and watching the balance grow (which is exiting). Between now and April 15th, you have two choices for paying your taxes.
1) You can leave the money there and use it to pay your tax bill when you get it after filing you taxes. You will get a bill after you file your taxes, and you can pay it from your tax savings account. Whatever is left (if anything) can be used however you would normally use a tax refund.
2) You can pay estimated taxes, which is usually the better plan.
Paying estimated taxes is usually the better plan because the various governments you pay taxes to (federal, state, possibly local) really really prefer to get their money on a regular basis (at least quarterly). There are penalties and fees associated with “underpayment of estimated taxes” at both the federal and state levels, and some states charge a pretty penny in late fees if you do not pay estimated taxes and you were supposed to. (There is sometimes a grace period if you did not have estimated payments the prior year, but that varies from state to state.)
Fortunately, they make the math pretty easy. You have to pay at least 90% of your upcoming estimated tax bill, or an “safe harbor” amount to show a good-faith effort to pay your taxes on a regular and timely basis. Most people use 100% of their prior year tax bill for the “safe harbor” amount, because it’s easy to calculate and covers the bases.
Estimated Taxes and Quarterly Payments
To avoid any penalties and fees that your various governments might want to exact for underpayment of taxes throughout the year, it would be wise to make quarterly estimated payments.
If you are filing as a sole proprietor, partner, S-corporation shareholder, and/or a self-employed individual, you generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return.
If you made more than $10,000, you probably owe $1,000 in taxes, so you should probably make estimated payments. If you overpay, you will get a refund, and you can tweak your savings amount for the next year.
Making Quarterly Payments
The federal government has an online payment system, Electronic Federal Tax Payment System (EFTPS) that you can sign up for to pay your quarterly estimated taxes. You have to enroll and wait for them to send you a PIN in the mail, so it’s a good idea to sign up at least two weeks before you need to make your payment.
They have also recently rolled out a system called “Direct Pay,” where you can set up a recurring withdrawal from a checking or savings account. This is easier to use than EFTPS becuase you don’t have to wait for the PIN to come in the mail. (For more information, visit bankrate.com’s explanation of the Direct Pay system.)
Some states have online systems for paying your estimated tax payments, too, but that varies from state to state, both in availability and ease of use.
“Self-Employment Tax,” aka FICA
Those of us who are self-employed, and make a bulk of our living that way, 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 pay half of this (7.65%) and take the other half out of your paychecks each month, but since you employ yourself, you’re responsible for all of it.
Fortunately, when you file your taxes, you get what would have been the employer’s half of your Self-Employment Tax back as an “above the line” deduction, which means it directly reduces your Adjusted Gross Income. So in the end, you only owe the same 7.65% of FICA that your W-2 employed friends are paying.
One way or the other, it would be wise to at least save the normal amount for your income taxes plus 7.65% to account for the portion of the Self-Employment tax that you will have to remit to the government. You may get a tax refund, and if you do, as mentioned above, you can always tweak your savings for income taxes and self-employment tax in the coming year.