Most people know that withholding taxes are deducted from their payroll checks. They know the deducted money is held by Internal Revenue Service until the tax return is filed. They also know they may owe more or they may get some back.
Many people don’t know that if enough has not been deducted, there may be penalties and interest added.
Contributions to a Simple Individual Retirement Account (IRA) are subtracted from gross earnings before the federal withholding deduction is calculated. This applies to only the federal withholding and not the Medicare tax or Social Security tax. The entire earnings are used for those calculations.
The contributions to a Simple IRA are not considered wages when the tax return is filed. The W-2 form shows wages before and after the contribution was deducted. Withholding taxes are not paid on IRA deductions until later years, when the money is withdrawn from the IRA. Early withdrawal before age fifty-nine and one-half years of age will be penalized. The tax rate is lower in later years for most people.
Many people enter into contract labor agreements. They don’t realize there is a lurking monster!
Employers can either pay cash with a signed voucher from the employee or they can pay by check. Taxes are not withheld. The employer most generally issues a 1099 form at the end of the tax year. A 1099 form replaces a W-2 form. A copy of the 1099 form goes to Internal Revenue Service. Uncle Sam wants his tax money.
Picture this; you have worked under a contract labor agreement all year and received a check each pay period. On December 31, you have not paid any taxes to Internal Revenue Service. Then you owe withholding tax for the entire year. You are also responsible for Social Security and Medicare tax. When Social Security and Medicare tax is deducted from a regular employee’s wages, the employer matches the amount. When a person works as contract labor, they are responsible for their portion, plus one-half of what the employer would have paid. Since none of this was paid for the entire year, you now have to cough up the withholding, Social Security and Medicare tax, plus penalties and interest.
When this happens, most of the time, Internal Revenue Service will work out a payment plan. Interest will be charged until it is paid in full.
The most important thing to remember, if you ever face this monster, is do not ignore any correspondence you receive from Internal Revenue Service. It can earn fines for you.
The worse scenario is when people think Internal Revenue Service does not know about contract labor earnings. It does happen. It can be two or three years later when the tax man comes knocking on the door. Taxes are owed. They also face compounded penalties and interest, and possibly a fine.
If you choose to work under a contract labor agreement, by all means, take responsibility for your withholding tax, Social Security and Medicare tax on a quarterly basis. They should be sent to Internal Revenue Service with a payment voucher.