Contract Attorneys Must Watch Their Tax Withholdings To Avoid A Nasty Surprise Bill

Contract attorneys must monitor withholdings and pay estimated taxes -- just like every solo practitioner does.

I received an email from a reader who unexpectedly got into tax trouble. Last year, his main job was growing his new solo practice. But in addition to his practice work, he did contract and document review work for others. He also worked several non-legal jobs, many which I wouldn’t consider “JD-Advantage.”

At the beginning of the year, he received multiple W-2s and 1099s. All of them reported small amounts of income. When he added them up, his total income came to about $80,000.

But when he finally got around to preparing his tax return, he learned that he owed $6,000 in federal and state taxes.

After reviewing his tax forms, it turned out that most of his W-2 employers only withheld 10 percent of his earnings for federal and state taxes. And some withheld none at all.

The surprise tax bill is a common issue I see with contract attorneys or freelancers who work multiple seasonal or part-time W-2 jobs during the year. This creates two problems. First is obviously is having to pay the back taxes plus penalties and interest. Second, they may have to save an equal amount of money so they won’t repeat this problem next year and in future years. So in the case of the reader, assuming there is no change in income for 2019, he will have to save $12,000 to pay the back taxes and ensure he withholds enough for 2019.

We are used to getting tax refunds when our only source of income is from W-2 wages. Most of us worked one full-time job as a W-2 employee where enough taxes were withheld. Or we may have worked a few seasonal jobs but our W-2 income was so low that we either did not meet the minimum income requirement for filing a tax return or the taxes. So we were under the impression that our employers or the tax system will withhold the proper amount of taxes.

The reason why that most employers (or their payroll departments) withhold so little is because the tax withholding rules assume that we do not have other sources of income.

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Also, the amount you are paid during a pay period can affect the tax withholdings. Generally, the more you are paid, the more taxes are withheld. So if you have multiple jobs with different employers who do not pay very much, you risk not having enough taxes withheld from your pay.

So how can a contract attorney avoid a similar fate? If you only earn money through W-2 income, you must keep track of how much taxes are withheld from your check and make sure that they meet the tax brackets of the IRS and your state. The new tax law has temporarily repealed itemized deduction treatment of employment-related expenses. It is generally recommended to withhold about 30 percent of your W-2 pay for federal and state taxes. It helps to claim zero exemptions when filling out the Form W-4 but sometimes that might not be enough.

If your employer cannot withhold any more, make estimated tax payments using the Form 1040-ES. These forms with payment must be submitted quarterly and are generally due on April 15, June 15, September 15, and January 15.

Also, if you run your own practice or receive 1099 income, that income, reduced by business expenses, is generally subject to income and self-employment taxes.

Unfortunately, the reader is stuck with the tax bill because he was not familiar with the W-2 tax withholding rules and mistakenly believed that W-2 wage earners would not owe taxes. Not only that, he will have to save more to make sure this does not repeat in 2019. Contract attorneys must monitor withholdings and pay estimated taxes — just like every solo practitioner does. They can no longer trust W-2s to do their tax planning for them.

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Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at sachimalbe@excite.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.