How to file taxes as an independent contractor
Being an independent contractor can be a career option that fits your lifestyle. Some people enjoy the flexibility being an independent contractor brings to their full-time job, and others use it to manage a side gig or two.
While being an independent contractor can be a convenient option, it does make your taxes a little more complex. It’s important to understand just what your responsibilities are as an independent contractor so you’re not caught off guard when tax time comes around.
In this guide, we’ll walk you through what you need to know regarding independent contractor taxes.
What is an Independent Contractor?
The IRS is pretty specific about who they consider an independent contractor and who they consider an employee. Employers must get this right, or they could face costly fines.
An independent contractor provides services but isn’t considered an employee — they’re considered self-employed. The IRS says that, in general, someone is regarded as an independent contractor if the payer can only direct the result of the work, not where and how it is done. The line does get blurred, so it’s up to employers to ensure they’re doing the work to understand if the person they’re hiring is considered an independent contractor or an employee.
Some examples of independent contractors include doctors, accountants, lawyers, and people who offer freelance services like web design or copywriting.
As an independent contractor, you can be a sole proprietor or register as a business like an LLC or a corporation.
How is an Independent Contractor Paid?
You’re paid on a consistent and regular schedule, like weekly, bi-weekly, or monthly when you're an employee. But as an independent contractor, there are no set rules as to how you are paid. It’s up to you and the payer to come up with the proper schedule and payment method.
For example, if you’re paid an hourly rate, you might invoice bi-weekly. Or, if you’re paid on a project basis, you might invoice at the end of the project. There’s no right or wrong way to set up your payment schedule.
Because you’re typically not paid through an employer’s payroll, you’ll need to have an alternative way to be paid. That could mean accepting credit card payments, using a payment processor like Paypal, or being paid by check.
How Are Independent Contractor Taxes Different?
While it may not seem like there’s much of a difference between an independent contractor and an employee — they’re both being paid for work performed — there’s a big difference when it comes to tax treatment.
Employers who hire part-time and full-time employees are responsible for several tax-related responsibilities. They’re required to withhold a specific amount of taxes from employee paychecks, often at federal and state levels. They must also withhold specific taxes for programs like Medicare and Social Security. At the end of each tax year, they’re required to issue W-2 forms, which report the salaries, wages, and tips that employees earn throughout the tax year.
With an independent contractor, those tax responsibilities no longer fall on the employer’s shoulders. They don’t withhold taxes from paychecks and provide an independent contractor with a W-2 at the end of the year. Instead, they’ll issue a 1099 NEC, which details how much they paid the independent contractor throughout the year.
How much do I pay in taxes as an independent contractor?
As we mentioned, when it comes to paying taxes as an independent contractor, the IRS considers you self-employed. That means that filing taxes will be a bit different than it is for an employee.
You’ll pay federal and state income tax (if applicable), just as you would if you were an employee. But there is another tax that independent contractors need to pay: self-employment tax.
Self-employment tax covers social security and Medicare taxes. Essentially, your self-employment tax is a flat tax rate meant to account for the Medicare and Social Security taxes that would have been withheld from your paycheck as an employee. Because employers typically pay for half of the taxes due, you’ll end up paying slightly more in self-employment taxes than you would as an employee.
You will be required to pay the self-employment tax as an independent contractor regardless of whether your business is structured as a sole proprietorship or an LLC. The current self-employment tax rate as of 2021 is 15.3%— 12.4% for social security and 2.9% for Medicare. If you were an employee instead of an independent contractor, you’d split that cost with your employer. You’d have 7.65% withheld from your paycheck to pay those taxes, and your employer would have to pay another 7.65% in taxes.
What tax deductions can I take as an independent contractor?
While extra taxes can be a downside for self-employed people, tax deductions are a silver lining. As an independent contractor, you’re able to take some tax deductions, which can save you some serious cash when tax time comes around.
Let’s walk through a quick reminder about how tax deductions work. Tax deductions reduce your taxable income. For example, if you earn $40,000 but have tax deductions of $5,000, your taxable income is $35,000. The deduction lowers your taxable income, which then reduces how much you have to pay in taxes.
Bottom line: tax deductions save you money on your final tax bill.
Some standard tax deductions you can take as an independent contractor include:
- Home office tax deduction
- Business portion of your phone bill
- Travel expenses
- Vehicle expenses related to business
- Retirement plan contributions
- Health insurance premiums
You can also take a deduction for 50% of your self-employment tax. For example, if you have to pay $1,500 in self-employment tax, you’ll be able to take a tax deduction of $750.
Do I need to pay estimated taxes as an independent contractor?
Have we mentioned there are many new things to learn when you’re filing taxes for the first time as an independent contractor? One that always seems to catch people off guard is the need to pay estimated taxes.
The US system is a pay-as-you-go tax system. What that means is that as you earn money, you should pay taxes. You don’t wait until the end of the year to cut Uncle Sam a check — he expects that you pay your taxes regularly throughout the year.
This is a lot simpler when you’re an employee. At each pay period, your employer withholds money from your paycheck to pay your taxes. That money is taken out of your paycheck and remitted to the government without you having to do anything.
For self-employed people, like independent contractors, the IRS has a process for paying your taxes four times throughout the year. These are your estimated tax payments, and the sum of these payments should match your tax liability for the year.
If the due date falls on a weekend or holiday, the due date is moved to the next business day.
If you will owe tax of more than $1,000 for the year, the IRS requires that you make estimated tax payments. Payments are made to the federal government using IRS Form 1040 ES. Check with your state for specific information on how to make estimated tax payments.
How do I pay taxes as an independent contractor?
When it comes time to file taxes as an independent contractor, you’ll need to fill out an additional form that gets submitted along with your income tax return, Form 1040. Most independent contractors will need to file Schedule C with their tax returns. Schedule C lists business income and expenses and shows how much you profit as an independent contractor.
The profit calculated on that schedule is then included on the front of your Form 1040 personal income tax return and used to calculate how much income tax you owe.
The due date for filing your Form 1040 and Schedule C is April 15. If you need an extension, you can file for an automatic six-month extension using Form 4868. But keep in mind that this is just an extension to file your taxes, not to pay them. If you have any tax due, that needs to be paid to the IRS by April 15.
Documents I need as an independent contractor to file my tax return.
In anticipation of filing your taxes as an independent contractor, you’ll want to gather the following documents, at a minimum:
- W-2. If you were an employee for some or all of the previous tax year, you’d still need to provide your W-2.
- 1099s. Collect all the 1099 forms you received, including 1099-NEC forms from your clients and any other 1099s you received as an individual.
- Copies of invoices and expenses. As a backup, make sure you have copies of all your invoices and past payments.
- Receipts for business expenses. If you’re going to deduct any business expenses, keep receipts in case of an audit.
- Bank statements. It’s also a good idea to keep your past few years of bank statements.
- Home office records. Keep records associated with your home office, including your rent/mortgage, utility, and other office expenses.
- Records of estimated taxes paid. Also, bring records of any estimated taxes you paid throughout the year.
You’ll also want to provide your clients with form W-9. This form gives them the information they need to issue you a 1099-NEC. That includes your name, address, business structure, and taxpayer identification number (TIN). You can use your social security number as a TIN or apply for EIN (employer identification number).
Preparing your books for filing
Because there are a lot of different things to keep track of, being organized is crucial. It’s a good idea to start using a bookkeeping system to track your income and deductions. Being organized won’t just make tax time more manageable, but it will help you maximize your tax deductions.
Need help filing your independent contractor taxes?
There is a lot to know when it comes to filing your taxes as an independent contractor. Having an expert in your corner who can help you make sense of the rules and identify any potential tax deductions can make all the difference. Taxfyle can connect you with a licensed CPA who knows the ins and outs of independent contractor taxes and can file for you, making your tax season much more effortless.
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