If the majority of your income is reported to the IRS in Box 7 of Form 1099-MISC, then please heed the following message: Make Estimated Tax Payments.
A number of my clients owe money to the IRS because they simply did not have enough money to pay their tax liability in full when the returns were due. While many taxpayers run into this predicament, the situation is exacerbated for those whose earnings are listed as nonemployee compensation on Form 1099-MISC. Why? These taxpayers simply do not account for the added self-employment tax on top of their income tax.
Here’s an example: Taxpayer T, a single male, earns $30,000 in nonemployee compensation in 2010. Jim takes the standard deduction, has one exemption, no expenses relating to his compensation and no dependents.
T will owe roughly $6,469 on his federal tax return. This is comprised of $4,239 in self-employment tax, $2,630 in regular income tax and a $400 Making Work Pay Credit. In all likelihood, T will not have $6,469 sitting around to pay the tax liability in full.
T’s solution is to make estimated tax payments on a quarterly basis. The amount will remain the same, but now he is spreading out the payments over the course of an entire year, which is much more manageable. The solution is simple enough, but the motivation for doing so often comes too late.
If you find yourself in a situation similar to T’s, do what it takes to begin paying your tax liability on a quarterly basis. If you can handle it yourself, great. If not, then hire a CPA to keep you on track. Whatever it is, try not to put yourself in T’s situation.
For information on how to property make estimated tax payments to the IRS, please see Form 1040-ES, Estimated Tax for Individuals.