Being an independent contractor can be one of the best career options that fit your lifestyle. Some individuals enjoy the flexibility that the job of an independent contractor provides, while others use it to manage a side hustle or two. There is no doubt in the fact that an independent contractor can be one of the finest options; however, it does make your taxes a little more complex. Moreover, it is critical to understand your responsibilities as an independent contractor, so you are not caught off guard when the tax season comes around. This blog is more like a guide; we will walk you through what you need to know regarding independent contractor taxes. So, let us get started.
What Is An Independent Contractor?
The Internal Revenue Service is pretty specific about who they consider an employee and an independent contractor. Employers need to understand this, or they could have to face hefty fines.
An independent contractor provides numerous services but isn’t considered an employee. According to the IRS, these self-employed individuals are regarded as independent contractors if the payer can only direct the outcome of the work, not where and how it is performed.
Moreover, it is generally up to the employers to ensure they are doing the work to understand if they are hiring an employee or an independent contractor. Major independent contractors are accountants, doctors, lawyers, or people who provide freelance services such as copywriting or graphic design. You can be a sole proprietor or register as a business like a corporation or LLC as an independent contractor.
How Is An Independent Contractor Paid?
You all may not know that employees are paid regularly or consistently, like weekly, bi-weekly, or monthly. However, there are no fixed rules for how you are paid as an independent contractor. It is generally up to you and the employer to come up with a suitable payment method and schedule. For instance, if you are paid on an hourly basis, you might invoice bi-weekly, or if you are paid on a project basis, you might invoice at the end of your work. There is no fixed way to set up your payment schedule.
As you are typically not paid through a payer’s payroll, you will need to have a different way to be paid. That could mean receiving credit card payments, using a payment processor such as Paypal, or being paid in cash or cheque.
How Does An Independent Contractor Pay Taxes?
As we read, things get a little more intricate with your taxes when you are an independent contractor. You will have numerous forms to file, and you will need to file estimated taxes regularly.
Reporting Self-Employment Income
There is a difference between reporting the income you earn as an independent contractor and reporting it as an employee. As an independent contractor, you need to file Schedule C along with your tax return. It details your profit and loss from business.
Always remember that an independent contractor is regarded to be self-employed, so it can be said that you are running your own business. Moreover, any income you earn as an independent contractor needs to be reported on Schedule C, and you will then pay income taxes on the total profit.
As an independent contractor, you have to pay more in self-employment taxes; however, there is also an advantage. You can take business deductions to reduce the amount of profit you pay income taxes on. Moreover, you will report these deductions along with your earnings on Schedule C.
You can take numerous business deductions as an independent contractor, such as home office deductions, health insurances, deductions for your phone bills, and many more. Some of you may be aware that the Tax Cuts and Jobs Act created another deduction that some independent contractors may qualify for, the qualified business income deduction, which may allow you to deduct up to 20% of your business income.
One of the major disadvantages of being an independent contractor is paying self-employment taxes. These independent contractor taxes are generally equivalent to the Medicare and Social Security taxes you pay as an employee. However, as an employee, your employer covers half the cost of the taxes. Moreover, independent contractors are required to pay the entire tax themselves.
Quarterly Estimated Tax Payments
The United States tax system is considered the ‘pay-as-you-go’ tax system, meaning one needs to make tax payments regularly throughout the year. When you are an employee, your payer is responsible for withholding income taxes from your paycheck and sending it to the government.
Thus, how does an independent contractor pay taxes? When you are an independent contractor, paying the government consistently throughout the year is your responsibility. Also, you do this by making quarterly income tax payments. You can calculate how much you need to pay the government every quarter by estimating your total income for the year or using the amount you have paid in estimated taxes the last year.
You won’t know precisely how much tax you owe until you file your personal tax return at the end of the year. However, you will want to spend time calculating this as if you underpay your estimated taxes; you could be subject to penalties.
Also, don’t forget to pay estimated taxes to your respective states. Apart from making federal estimated income tax payments, you will be needed to pay your state throughout the year as well.
As an employee, you receive a W-2 every year presenting how much you made and how much you had retained from your paycheck for taxes.
Instead of a W-2, you will receive a 1099-MISC as an independent contractor. This form gives an account of how much you were paid throughout the year. You can use those details to double-check that you report all your income earned through the year.
Moreover, if you earned less than $600 from a client during the year, you won’t receive a 1099-MISC; however, you will still need to report that income on your Schedule C. Hence, keeping a good accounting system is significant.
Major Documents Required For An Independent Contractor To File Tax Return
In anticipation of filing taxes as an independent contractor, you will want to have the following documents, at a minimum:
- If you were an employee for quite some or all of the last tax year, you would still need to provide your W-2.
- Gather all the 1099 forms you received, including 1099-NEC forms from your clients and any other 1099 independent contractor taxes forms you received as a person.
- Independent contractors need to have copies of invoices and expenses. As a backup, you need to have records of invoices and past payments.
- Also, if you are going to deduct any business expenses, keep receipts for business expenses in case of an audit.
- Keeping bank statements of your past few years can also be a great idea.
- Moreover, keep records related to your home office, including mortgage/rent, utility, and multiple office expenses.
- Keep records of any estimated taxes you paid throughout the year.
Furthermore, being an independent contractor, you will also have to provide your clients with the Form W-9. It gives them the information they require to issue you a 1099-NEC which generally includes details such as your address, name, taxpayer identification number (TIN), business structure, and many more. You can also use the social security number as a TIN or apply for an employer identification number.
Visit the Business Tax Benefits website if you have queries such as how to file independent contractor taxes. Our experts strive to keep you updated regarding taxes. Apart from this, you can clear all your major doubts related to employee retention tax credit and the CARES Act. Feel free to contact us.