Working as a contractor can provide you with freedom few employees experience, but there are also drawbacks. One of the most significant pitfalls to life as an independent contractor involves your taxes. Working as a contractor subjects you to the self-employment tax, and makes your tax planning and preparation more complicated.
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When you work as a contractor, you are considered to be self-employed, and that subjects you to the self-employment tax. The self-employment tax represents both the employer and the employee share of the Social Security and Medicare payroll taxes. When you work for someone else, your employer pays half of these two taxes and you pay the rest. But as a contractor, you are considered both the employee and the employer, and that means you pay both sides of both of these taxes.
Estimated Tax Payments
When you work as a contractor, you do not have the luxury of an employer who withholds taxes from your paycheck. That means that you will have to pay those taxes yourself, and you might need to make those payments more than once a year. In most cases, if you expect to owe the IRS more than £650, you will have to make estimated tax payments on a quarterly basis. It is a good idea to consult with a CPA, or at least run the numbers through your tax software, to prepare the forms and determine how much you should pay.
Separate Bank Accounts
As a contractor, track both your income and any expenses related to running your business and serving your clients. That is why it is so important to establish a separate bank account just for your business. Commingling your business and personal accounts can make it difficult to determine which expenses are deductible, and even more difficult to justify those expenses in the event of an audit.
Year Long Tax Planning
When you work for an employer who is responsible for withholding taxes from your paycheck and sending that money to the IRS, you can restrict your tax planning to once a year. But when you work for yourself as an independent contractor, your tax planning takes on a year-round structure. You need to constantly monitor the earnings you make as a contractor, then run the numbers and make sure you are paying enough in quarterly taxes, and putting aside enough to cover any potential shortfall.
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