David A. Caplan, CPA, MBA - Certified Public Accountant

Q & A

I am an independent contractor for the first time this year. Do I need to pay estimated taxes?
-J.R., Philadelphia, PA

The first truth that needs to be known here is that the IRS would ALWAYS prefer to have their money up front. However, that does not necessarily mean that you must comply. If you are an independent contractor, you are not having taxes withheld from a paycheck, and you must estimate your tax liability. There is a safe harbor (not a nautical term), though, which allows you to potentially limit the amount you pay in during the year. The safe harbor rule is that you must pay in either 90% of this year's tax liability or 100% of last year's tax liability (110% if your adjusted gross income last year was in excess of $150,000) to avoid a penalty. I'll bet you're saying "but I got a refund last year" (I can hear you). The term "tax liability" refers to your total tax before withholdings (line 56 on Form 1040), not the amount you had to pay by April 15. Remember that the safe harbor rule merely eliminates the penalty. You may still have significant tax due at the end of the year. Also, remember that this is a FEDERAL safe harbor - your state may have different rules.

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