Independent Contractors Are Subject to the Self-Employment Tax

• Independent contractors are workers who perform services for clients who do not withhold taxes from their pay. The Internal Revenue Service defines contractors as those who perform services for people who "have the right to control or direct only the result of the work and not the means and methods of accomplishing the result." Anyone who works as an independent contractor is subject to paying a self-employment tax on all earnings made from contracting. While a contractor may not technically own her own business, she is paid directly by those for whom she performs services, so the money she earns is taxed in the same way.
  
  

How the Self-Employment Tax Works

• The self-employment tax is a pay-as-you-go, tax estimate system. A self-employed individual or contractor is required to make quarterly tax estimations and pay them to the IRS. Self-employed workers making over $400 in self-employed income must deduct 13.3 percent for Social Security and Medicare, as of 2011. This deduction only applies to the first $106,800 earned in self-employment income. Above the standard payment amount, the earner must calculate additional taxes based on his total income and tax bracket. Because a contractor does not know for certain how much money he will make over the year, he may not know which tax bracket he will end up falling in, which can make estimations difficult. Any difference between estimated taxes paid and actual taxes owed are made up at the end of the tax season when taxes are filed. Underpayment of estimated taxes will require the payment of additional taxes, and an interest-based penalty fee on the taxes owed. If the estimated taxes overpay actual tax owed, the government will send a refund.
  
  

Other Considerations

• Many contractors do contract work part time and carry on other full-time positions as an employee. Such workers may not be subject to the self-employment tax on their self-employment income if their federal withholding from their other job, plus tax credits, will shrink their tax owed to less than $1,000. Basically, the self-employment estimated tax is a way to account for the time value of money: A dollar earned at the beginning of the year is worth slightly more than a dollar earned toward the end of the year, because the first dollar can be invested and earn income over the course of the year. Allowing self-employed individuals to keep all their income until the end of the year before paying would give them an advantage over normal employees, whose taxes are withheld from every paycheck.