Offering consultancy services gives you the chance to make money with your knowledge and experience. As such, you could decide to work for a particular company and be on its payroll and avoid self-employment tax. You could also decide to be your own boss by going the self-employment way and pay the tax. Either way, you are considered an expert whose service is valued at a price. You shouldn’t let self-employment tax scare or deter you.
For a consultant working as an employee of a specific company, the onus of tax payment may be on the given company. However, for an independent consultant who offers his or services like a freelancer would, the case is different. Definitely, it behooves the independent consultant to pay his or her taxes as and when due.
Of course, being self-employed exempts no one from paying taxes. As a freelance consultant, you are expected to pay both the federal income and self-employment taxes. In addition to this, you need to take note of the state and local taxes too. Thus, if you need more information on all these, the following paragraphs contain all you seek.
Payment of business income tax
Income tax is generally imposed on income generated by individuals and businesses. So, from the taxes paid, governments create revenue, and use it to fund various developmental and welfare projects. Personal income taxes are levied on the wages and salaries of individuals. However, business income taxes are applicable to organizations, companies and self-employed people.
Since independent IT consultants are considered self-employed, then they are required to pay the business income tax. To know your specific income tax, you may have to know what tax bracket your income belongs to. Typically, tax rates can fall between 10% and 37%, depending on your net profit for the year.
It is important for you to note that your taxable income is derived after you must have got your net income. To arrive at your net income, you deduct your operating and capital expenses from the overall income made. Technically, that overall income is known as gross income.
Understand also that the United States operates a progressive tax system. And this implies that your tax rates tend to increase marginally as your income increases. It is nonetheless recommended by the Internal Revenue Service that you pay your taxes on a quarterly basis. This may require that you take note of your estimated tax liabilities.
Payment of self-employment tax
Apart from the income tax, the self-employment tax is another tax that business owners in the gig economy are required to pay. So, as an independent IT consultant, it is essential that you know about it. In the US, this tax is pegged at the rate of 15% of your net income, and is divided into: Social Security (12.4%) and Medicare (2.9%).
While Social Security caters for old-age, survivors, and disability insurance, Medicare is concerned with hospital insurance. Besides, you should understand that the Social Security and Medicare taxes are also binding on employees. The only difference is that theirs are withheld and paid by their concerned employers — all the more so at a 50/50 share.
As a freelance consultant self-handling your business, you have to bear the cost of the self-employment tax in full. But that’s if you already have a net earning of $400 at least. In addition, it is essential to know that you would be responsible to pay a 0.9% surtax on Medicare once you begin to make over $200,000— or $250,000 for married couples. This additional Medicare tax caters for parts of the Affordable Care Act including premium tax credit and the like.
For you to be able to pay your self-employment tax, the IRS maintains that you need to have a Social Security Number (SSN). Alternatively, you may get yourself an Individual Taxpayer Identification Number (ITIN) in case you are not eligible to get an SSN.
Make Quarterly Tax Payments
The IRS mandates that individuals pay taxes as income is earned or received, either through withholdings or estimated tax payments. IT consultants, particularly those that operate as 1099 contractors, generally do not have taxes withheld from their income. As a result, the IRS mandates that they make estimated quarterly tax payments. So, while these payments are not taxes per se and the IRS currently does offer penalties for individual’s failing to pay, we are including them here. Making estimated quarterly payments allows you to avoid paying a hefty tax at the end of the year. It also allows you budget your finances better. However, the following is the official IRS timetable for these payments for 2022:
|1st Quarterly Estimated Tax Payment||April 18, 2022|
|2nd Quarterly Estimated Tax Payment||June 15, 2022|
|3rd Quarterly Estimated Tax Payment||September 15, 2022|
|4th Quarterly Estimated Tax Payment||January 17, 2023|
All in all, you should take cognizance of the fact that you might be in for a tax audit, should you default on your tax payments. Remember also that the tax situation of an IT consultant can be different from that of an employee IT professional. Unlike employees who would receive the W-2 form, independent contractors often get the 1099-MISC or 1099-NEC from clients. So, filing your business tax return is up to you, and you have to be honest about it as your client may have sent theirs to the IRS.