A contractor may receive a client’s payment without the paycheck withholding that employees commonly see. That does not mean the tax bill disappears; it means the worker may need to pay taxes directly during the year. The IRS describes estimated tax as the method self-employed people use to pay income tax and Social Security and Medicare taxes when no employer is withholding them. Form 1040-ES provides a worksheet for working out an estimate, which can be revisited as business income changes.
The missing withholding changes who pays
For an employee, federal income tax is generally withheld from regular pay, and employers are required to withhold employment taxes, including Social Security and Medicare taxes. The amount of income tax withheld depends in part on earnings and the information provided to the employer on Form W-4. Internal Revenue Service
A sole proprietor, independent contractor, gig worker, or other person in business for themselves generally faces a different process. The IRS says self-employed people generally pay estimated taxes quarterly and file an annual return. Their estimated payments cover income tax as well as self-employment tax, which refers to Social Security and Medicare taxes for people working for themselves. Internal Revenue Service
An estimate follows business results
A hypothetical first-year contractor expects to earn money from several clients but has no employer withholding tax from those payments. The contractor needs to estimate expected earnings for the year and use Form 1040-ES to work out estimated taxes. The IRS notes that first-year self-employed workers need to estimate the income they expect to earn; it also says the form’s worksheet is used to figure the taxes. Internal Revenue Service
The key figure is not simply the total money received from clients. The IRS says a person generally calculates business net profit or loss by subtracting business expenses from business income. Net profit becomes part of income on the annual return, while a loss may be deductible in some circumstances and may be limited in others. That distinction helps explain why a useful estimate depends on business results, not just gross receipts. Internal Revenue Service
Revisit the calculation when the year changes
Suppose the hypothetical contractor’s work slows after an initially busy stretch, or a new project raises expected earnings. The IRS says the worker can complete another Form 1040-ES worksheet to refigure the estimated tax for the next quarter if the original estimate was too high or too low. Updating an estimate lets payments reflect a changed view of annual earnings rather than treating the first projection as fixed. Internal Revenue Service
The IRS says the Form 1040-ES worksheet is similar to Form 1040 or 1040-SR and that a prior year’s annual income tax return is needed to fill it out. That may make the first year more uncertain: the taxpayer must estimate expected earnings without a previous year of self-employment income to use as a reference. The form provides a calculation method, not a prediction of what the business will earn. Internal Revenue Service
Estimated payments and the annual return do different work
Estimated payments address taxes during the year; the annual return reports the business income or loss and the taxes owed. For a sole proprietor, the IRS identifies Schedule C as the form used to report business income or loss, and Schedule SE as the form used to report Social Security and Medicare taxes. The income or loss calculated on Schedule C feeds into the self-employment tax calculation. Internal Revenue Service
Form 1040-ES also offers payment vouchers for people mailing payments, and the IRS lists phone and online payment options. Those are ways to submit a payment, separate from the worksheet’s role in calculating it. Because the annual return and estimated payments serve related but distinct purposes, paying estimates does not replace reporting the year’s results on the return. Internal Revenue Service
Sources & further reading
- Self-employed individuals tax center ↗Internal Revenue Service
- Tax withholding ↗Internal Revenue Service
