In the U.S., taxes are set up on a “pay-as-you-go” system, which means the Internal Revenue Service expects money to be paid throughout the year. That W-4 form you fill out when you start a new job tells your employer exactly how much money to withhold from every paycheck and submit to the IRS on your behalf. But not every employer takes taxes out of each check. In fact, an increasing number of workers are being classified as independent contractors, which means no money is withheld and submitted at all. But that extra money coming in every two weeks can actually become a problem if you wait until tax time to worry about it.
No Federal Income Tax Withheld
If you’re a full-time salaried employee, you and your employer share responsibility for ensuring your taxes are paid throughout the year. Although your employer may take those taxes out, you’ll ultimately be responsible for ensuring you’ve paid enough throughout the year. When you file, you’ll list what you made and what taxes you paid during the tax year. If your employer didn’t take out enough, you’ll owe on April 15. If your employer took out too much, you’ll get a refund.
Unfortunately, you may not realize your employer isn’t withholding taxes until too late. It’s important to pay close attention to your paychecks and make sure income tax and Federal Income Contributions Act (FICA) both have amounts listed next to them. Although the responsibility for paying your taxes ultimately falls on you, employers face criminal and civil penalties for failing to withhold taxes on employees.
Income Taxes for Independent Contractors
If you notice taxes aren’t being withheld, the first question should be directed to your employer. Did you complete a W-4 form when you were on boarded for the position? Check your employment agreement and determine whether you were told you were a salaried employee or an independent contractor. If you’re working on a freelance basis, your employer isn’t required to withhold taxes on you. Even if you’re going into an office every day, you can be classified as an independent contractor.
Independent contractors are still expected to pay taxes throughout the year, not just at tax time. If you don’t, you could find yourself hit with costly penalties in April. The IRS recommends paying estimated payments during the year if you expect to owe $1,000 or more once all of your deductions and credits are taken. The IRS provides a work sheet as part of Publication 505 to help you determine whether you should pay quarterly and, if so, how much. You’ll calculate how much you’ll pay in taxes for the entire tax year and divide it by four, remitting payments in mid-April, mid-June, mid-September and mid-January.
Not Enough Taxes Withheld
Instead of no federal taxes taken out of paycheck, you may simply find that not enough is being withheld. How do you know that? The IRS actually has a helpful paycheck checkup tool. Things can get complicated, especially if you have a two-income family or you have dependents, but this tool asks the necessary questions to determine if you’re paying enough. Of course, the time you’ll most be aware of whether you’re having enough or too little held out is in mid-April, but by then you’ll either owe or be handed a huge refund check.
You can adjust tax withholding at any time throughout the year, not just at tax time. You’ll simply give your employer a new W-4 with the updated information. It’s important to note, though, that the changes won’t be retroactive. You may not even see the corrections on your paycheck for several weeks, depending how far in advance your employer processes payroll. You can use the IRS Withholding Calculator to determine exactly how to complete the form, whether it’s your first day at work or you’ve been there for decades and want to make a withholding change.
Penalty for Underpayment of Taxes
The penalty for underpayment isn’t as hefty as you may think. If you don’t pay enough in taxes, you’ll use Form 2210 to determine exactly what you owe. In some cases, though, you won’t need to fill out the form since the IRS will calculate your penalty. If your situation is that no federal taxes were taken out of your paycheck, you’ll still have to pay this penalty, although it is a relatively small one, based on a percentage of the taxes you owe for the year.
Self-employed individuals are especially susceptible to these penalties since no one is withholding taxes from pay. The sharing economy means more people than ever don’t have taxes withheld. Those working for services like Uber and Lyft are considered independent contractors, which means they’re responsible for making sure their taxes get paid since they see no federal taxes taken out of paycheck.
Tax Time Forms
Whatever your employment setup, you’ll know early in the year whether you’re in a situation with no federal income tax withheld. Employers are required to send a W-2 form to every employee it paid $600 or more by Jan. 31 each year. If you don’t receive your W-2 by that date, you should contact your employer and check into it.
But even when you do get your W-2, you may find it confusing. Box 2 will detail the federal income tax withheld, but you’ll also see withheld Social Security wages in Box 4 and withheld Medicare tax in Box 6. Box 12 will list miscellaneous other taxes withheld, including uncollected taxes on tips and nontaxable sick pay. If you don’t see taxes listed, or you feel the numbers are incorrect, you’ll need to check with your employer to clarify exactly what was sent to the IRS throughout the year. This can also be the opportunity to do a paycheck checkup and adjust tax withholding if you didn’t have enough taken out in the previous tax year.
If you’re self-employed, though, the form you’ll receive in the mail is a 1099. If an employer paid you $600 or more, you should get one of these forms in the mail. However, if you made more than $400 in self-employment income, you’re obligated to report every dollar you earn, even if you don’t receive a form. That means if you earn $50 from one client and $600 from another, that $50 will still need to be added to your $600, along with any other earnings, and reported on your taxes. Self-employed individuals generally must track earnings from the start of the year to make sure they report everything.
Completing Your W-4
Whether you’re starting a new job or interested in trying to adjust tax withholding, it’s important to know how to complete your W-4. The biggest part of this is deciding how many allowances to take. Claim fewer allowances and you’ll get a huge tax refund. Claim more allowances, and you may end up owing a refund, especially if you don’t have enough dependents.
If you’re doing self-employment work on the side with no federal income tax withheld, you might be able to make up for this by having more sent to the IRS at your day job. You do this by taking your allowances down as far as possible. By having more taken out of each check, you’ll be able to make up for the taxes you’ll owe on the money you’re earning on the side. The same goes for freelancers who have spouses with salaried employment. Having them reduce their allowances can eliminate your need to pay estimated tax payments throughout the year.
- US Tax Center: Withholding Tax: The Basics
- IRS: Employer and Employee Responsibilities - Employment Tax Enforcement
- IRS: Estimated Taxes
- IRS: Publication 505 (2018), Tax Withholding and Estimated Tax
- IRS: Time for a Paycheck Checkup
- IRS: IRS Withholding Calculator
- Bankrate: What to do if you don’t get your W-2 from the boss and you want to file taxes early
- Forbes: How To Read And Understand Your Form W-2 At Tax Time
- SmartAsset: A Guide to Filling Out Your W-4 Form
- SmartAsset: How Many Allowances Should You Claim?
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.