HOW MUCH SHOULD I SET ASIDE FOR TAXES?

A long-time client (actually they all are) just sent me the following email -

“I have an opportunity to do some consulting work for about 12 weeks and would like to understand how much I should set aside for taxes.”

This is a common question.  Here is how I responded -

“As a ‘self-employed’ contractor you will receive a Form 1099-MISC for your payments.

You can deduct direct expenses related to the consulting "gig" - business meals and entertaining, possible mileage at 57.5 cents per mile (not commuting), supplies and materials, research, etc.

You will pay federal and NJ state income tax on the net amount (after deductible expenses) at 25% for Sam and 5.525% for Chris {these are her anticipated tax brackets based on her 2014 Form 1040.  Sam is obviously “Uncle Sam”, and Chris is “Uncle Chris Christie”, as she is a NJ resident}.  You will also pay ‘self-employment tax’ (the equivalent of Social Security and Medicare) to Sam on the net amount.  The effective cost of the self-employment tax is 12.36%.

A safe bet would be to set aside at least 40% of the gross payments (assuming you will have some deductions).

For 2013 you received a {sizeable} federal refund - so, depending on the income, you would not necessarily be ‘out of pocket’ for Sam.  You would just get a smaller refund.  You did owe Chris last year, so you would very likely be ‘out of pocket’ for the state income tax cost.”

While the self-employment tax rate is 15.3%, this is applied to 92.35% of net earnings from self-employment. 

As I explain in one of the discussions in my THE NEW SCHEDULE C NOTEBOOK -

“If net earnings from self-employment for the year is $10,000 (and this amount combined with your Social Security wages from W-2s is less than maximum income base) you will pay $1,413 in self-employment tax ($10,000 x .9235 = $9,235 x 15.3%). So in effect the self-employment tax is 14.13% of your Schedule C (or C-EZ) bottom line.

You are also allowed an ‘above-the-line’ deduction (an ‘adjustment to income’) for one-half of your self-employment tax from Schedule SE.

So, taking into account the 50% self-employment tax adjustment to income, the “effective” cost of your self-employment tax is –

•  15% Bracket = 13.07%

•  25% Bracket = 12.36%

•  28% Bracket = 12.15%

•  33% Bracket = 11.80%

•  35% Bracket = 11.66%”

In her case, based on her 2014 refund, she would not necessarily need to make a 4^th Quarter 2015 federal estimated tax payment in January of 2016 – again depending on the amount of the income.  But it couldn’t hurt to make a 4^th Quarter NJ estimated tax payment – in December 2015 instead of January 2016 to get a deduction on her 2015 return.

Any questions?

TTFN