Finding Your Income 1099 Tax Bracket for Independent Contractors
Most people who work as employees don’t spend much time thinking about their tax bracket for federal income tax withholding. The federal withholding system is designed so that their employer should be determining their tax bracket based on their income and dependents to hold back the proper amounts and passing them along to the IRS.
It’s another story for freelancers and independent contractors who have their income reported on Forms 1099. If you are earning Form 1099 income you need to know your income tax bracket because you do not have the benefit of employer withholding and must send estimated tax payments to the IRS each quarter. If you pay too little in estimated taxes the IRS may subject you to tax underpayment penalties.
An additional wrinkle faced by those working for themselves is that they need to pay the self-employment tax on their business income, which also needs to be accounted for in your estimated tax payments.
Will you need to pay estimated taxes?
Most self-employed individuals will need to make estimated tax payments, but they are not the only ones. Basically, anyone who receives income that is not subject to federal income tax withholding must pay estimated taxes, including those earning income from:
- Capital gains from the sale of assets
- Some types of alimony
If you don't estimate your quarterly taxes and make your payments, this will usually result in the IRS imposing penalties. Likewise, if you underpay for a quarter you will be subject to a penalty based on each installment that you underpaid.
What income is subject to the income tax?
Your estimated tax payments are based on the amount of tax you expect to pay when you file your federal income tax returns for the year. You start the process of finding your taxable income by calculating your adjusted gross income (AGI).
To calculate your AGI you begin with the self-employment income that you reported on your Form 1040 Schedule C. Your AGI will also include any wages you earned as an employee and any other taxable income for the year.
After adding up the “income” portion of your AGI, you will then work on the “adjusted” part of the equation. These adjustments are known as “above the line” deductions that are available to you even if you claim the standard deduction on your personal income tax filing.
The above-the-line deductions are generally found on the Form 1040 schedule 1 and include such items as the self-employment tax deduction, the self-employment health insurance deduction, and contributions to a health savings account (HSA).
To find your taxable income you will take your AGI and then subtract either the $12,000 standard deduction ($24,800 for taxpayers who are married and filing jointly) or your itemized deductions.
Finding your tax bracket for your filing status
Once you have calculated your taxable income you can then use that number to find your tax bracket. Because your estimated tax payments are based on the income tax you expect to owe for the year you will use the same tax brackets as you would for a Form 1040.
For the 2020 tax year the IRS has set the following marginal tax rates for single filers and joint:
- 10% for individual income of $9,875 or less ($19,750 if married filing jointly)
- 12% for individual income over $9,875 ($19,750 if married filing jointly)
- 24% for individual income over $40,125 ($80,250 if married filing jointly)
- 32% for individual income over $85,525 ($171,050 if married filing jointly)
- 35% for individual income over $207,350 ($414,700 if married filing jointly)
- 37% for individual income over $518,400 (622,050 if married filing jointly)
Remember, just because your taxable income lands you in a specific tax bracket does not mean you will pay that rate on all of your income. The United States has adopted a progressive income tax system where your income is taxed at differing rates and the marginal rate is simply the highest rate you will pay.
For example, if you are single and have $50,000 in taxable income after claiming the standard deduction you will have a 24% marginal tax rate. In other words, for each additional dollar you earn will be taxed at 24%. However, the first $9,875 will be taxed at 10% and any additional income you receive will be taxed at 12% until your income hits $40,125. Then any income over $40,125 will be taxed at 24%.
The bottom line is that if you claimed the standard deduction you would pay about $6,708 in taxes on your $50,000 in taxable income, which is an effective tax rate of roughly 11%. That is less than half the marginal rate of $50,000 in taxable income.
What about the self-employment tax?
As we have already noted, you must include your estimated self-employment taxes in your quarterly estimated tax payments. When you work for someone else as an employee, your employer will cover half of your Social Security and Medicare tax payments, which are often referred to as the “payroll tax.” However, when you are self-employed you are responsible for paying the tax liability both the employer’s and employee’s portions of the payroll tax, which is the self-employment tax.
The self-employment tax rate is 15.3%, with 12.4% of that amount covering your Social Security tax and 2.9% covering your Medicare tax. Once your income is higher than $142,800 (for 2021) you are no longer required to pay the Social Security portion of the tax and your tax rate drops to the 2.9% necessary to cover the Medicare tax you must still pay. If your income is more than $200,000 an additional 0.9% Medicare tax may apply. The additional tax kicks in at $250,000 if you are married filing jointly.
What are the underpayment penalties for estimated taxes?
Unfortunately, if you place yourself in too low a tax bracket or otherwise underpay your estimated taxes, the IRS is rarely sympathetic. The IRS usually calculates the tax underpayment penalty for the self-employed as the federal short-term rate plus 3% for each quarter where you underpaid.
Since the penalty calculations can quickly get complex, the IRS usually just does the calculation for you and then sends you the bill. If you would like to have the IRS calculate your penalty for you, simply leave the penalty line of your return blank.
Should you overpay your estimated taxes the IRS will issue a tax refund for the overpaid amount after you have filed your personal federal income tax return in the same way it does when you over-withhold as an employee.
How to avoid triggering penalties
The self-employed can generally avoid paying a penalty to the IRS if their estimated tax payments totaled at least 90% of the tax that is due for the current year or 100% of the tax that was due the previous year, whichever is less.
You can also avoid the penalty for underpaying estimated taxes if you owe less than $1,000 for the year. Likewise, if you did not need to file a return the previous year you will not be subject to the penalty.
Getting your underpayment penalty waived
If you request a waiver from the IRS, it will sometimes waive the underpayment penalties for your estimated taxes. However, this only occurs in limited circumstances. Generally, a waiver is granted when the following are true:
- Your failure to make the payment was reasonable
- You are more than 62 years old or suffer from a disability
- You did not miss the payment out of willful neglect.
Additionally, the IRS will sometimes find it would be inequitable to impose a penalty if you underpaid your estimated tax due to a natural disaster or similar unusual situation.
The IRS does not issue penalty waivers automatically, you need to request one using a Form 2210. You will also need to file a statement explaining why you should be issued a waiver and provide supporting documents.
Filing your estimated taxes
To pay your estimated quarterly taxes you will need to fill out and file a Form 1040-ES. Fortunately, if you would like to file without using a tax professional or tax software you can use the worksheet and instructions that are included with the form to estimate the amounts of income tax and self-employment tax you will be required to pay.
There are several ways to pay your estimated tax bill. The first is by mailing a tax voucher with your check or money order. You can also pay your tax using a debit or credit card by going to IRS.gov/Payments.
Finally, you can take advantage of the Electronic Federal Tax Payment System (EFTPS). To use the EFTPS you will need to enroll by calling customer service to get an enrollment form and instructions. Once you have enrolled in EFTPS you can electronically move funds to the Treasury Department by either calling a toll-free number and using the automated telephone system or using free software to do so online. Additionally, you utilize the EFTPS through your bank or financial institution.
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At Keeper Tax, we’re on a mission to help freelancers overcome the complexity of their taxes. That sometimes leads us to generalize tax advice. Please email email@example.com if you have questions.