Some of us are used to the routine of working for an employer. Employees show up, log their 9-to-5 days, go home, and repeat the cycle the next day.
Others have found new ways to generate income. According to the U.S. Bureau of Labor Statistics, nearly 7% of total employment in the U.S. is made up of independent contractors.
Both employees and independent contractors work hard to generate income fairly. However, these two positions are treated differently during tax season.
So, what are the major differences? How do I file independent contractor taxes?
If this is your first year working as an independent contractor, you might not know where to start. In this guide, we will highlight everything you need to know about filing as an independent contractor.
Who Qualifies as an Independent Contractor?
Before you read any further, you should first determine if you actually work as an independent contractor. A worker may be unsure if he or she qualifies as an employee or independent contractor. To put it simply, a regular employee is someone who works for a business owner.
Think about the position you have. If you experience any of the following scenarios, you are likely an employee rather than an independent contractor:
- Someone assigns you to work specific hours and days
- You must go through a supervisor to seek approval for certain tasks
- You must make periodic reports to a superior
- You receive a set hourly wage or salary
On the other hand, independent contractors are self-employed. They complete work for others but are hired on a contractual basis. They perform work for a specific amount of time or complete a project with pre-established guidelines.
To be an independent contractor according to the IRS, you must direct and control the professional and financial aspects of your job.
Some common examples of independent contractors include:
- Accountants or attorneys who bill their clients by the hour
- Auto mechanics who set their own prices
- Piano instructors who rent their own facilities to teach at
- Repairmen who seek out their own handyman gigs
These are just a few positions. Independent contractors encompass positions across various fields. Some independent contractors work on their own, while others technically work for a business owner.
If you’re not sure if the company you work with classifies you as an independent contractor, you need to find out before it’s time to file. Read over your contract or ask someone who will know.
What Taxes Do I Have To Pay as an Independent Contractor?
Before you learn what taxes you have to pay as an independent contractor, you should understand how taxes work for a regular employee.
Let’s paint a hypothetical situation. Let’s say Jane is an hourly worker for a nationwide grocery store. She works as a cashier, gets paid $12/hour, and has regularly-scheduled shifts. According to the IRS, she is classified as an employee.
Every week, she receives a paycheck that’s deposited into her checking account. She won’t see all of the money she earns. Rather, some payroll taxes will come out of her final check.
Jane’s employer will withhold federal, state, and local taxes depending on how she fills out Form 4-W. This form alerts employers to how much they need to withhold for each employee.
Additionally, Jane’s employer will take out 6.2% for Social Security and 1.45% for Medicare. Her employer will pay out-of-pocket for the remaining half of her Social Security and Medicare tax requirements (another 6.2% and 1.45%).
If you are an independent contractor, these procedures go out the window. Because you are self-employed, you become responsible for all of your Social Security and Medicare. The self-employment tax rate is 15.3%, which can be a large blow for independent contractors who are filing for the first time. When it’s time to file, you will need to fork over 12.4% for Social Security and 2.9% for Medicare. You will also be responsible for federal, state, and local income tax.
Some independent contractors will pay themselves as W-2 employees. This process can be confusing, so most self-employed people avoid it. Most just pay their federal income tax and self-employment tax directly to the IRS.
How Do Independent Contractors Report Their Taxes?
Self-employed independent contractors file using Form 1040 (Schedule C).
To get records of income, you will collect a Form 1099-MISC from every client. These forms are records that someone other than an employer gave you money. The entity that’s paying you needs to fill out a 1099 form and send a copy of it to both you and the IRS.
Some self-employed independent contractors may be tempted to ignore their tax obligations. I’m only one worker among millions.
They believe they can go unnoticed by the IRS. However, every Form 1099-MISC will have your taxpayer identification number or Social Security number on it.
Because of Form 1099-MISC, the IRS will always know if you received money from a client. More importantly, it will always know if you fail to report that business income on your self-employment tax return.
That’s why you must report all of your income honestly. If you don’t, you could face severe financial penalties or legal trouble. We’ll cover that more in-depth later.
Tax Deductions for Self-Employed Independent Contractors
Let’s say you had a great first-year as an independent contractor. You billed over $100,000 for work you completed for various clients!
Obviously, this won’t all be profit. You can account for state and local income tax to lower your liabilities.
You also have to pay for certain items to perform your services. The IRS doesn’t know how much you spent in the process, so you’ll have to report self-employment tax deductions.
Can I Deduct Business Expenses?
Absolutely! Some examples of business expenses you may deduct include:
- Business insurance
- Advertising costs
- Equipment purchases
- Rent or lease payments
- Legal or other professional expenses
- Vehicle-related business expenses
- Home office expenses
Some other less common examples of business expenses include health insurance premiums and interest paid to student loans.
However, you cannot deduct expenses at random. They must be related to your small business’s operations or qualify as IRS-approved personal expenses.
For example, you cannot make deductions for health insurance premiums if you have access to your spouse’s health insurance plan.
I’m Not Sure If a Business Expense is Deductible
Not sure if a business expense is deductible? If you’re not familiar with the IRS’s guidelines, the line can be blurry when it comes to which business expenses are deductible.
Visit the IRS’s website to view a comprehensive list. This list tells you what business expenses are deductible. It also provides guidelines for the amounts you can deduct.
Do I Have to Make Estimated Tax Payments?
In most cases, yes. A self-employed person has to make estimated tax payments to cover FICA and income tax. But, it depends on how much you expect to owe in taxes.
Self-employed independent contractors who expect to owe less than $1,000 in self-employment tax do not have to make estimated payments. Rather, they can make one lump payment.
Even if you anticipate owing less than $1,000, you should consider making estimated payments. This will ensure you don’t under-pay and will prevent you from incurring penalties.
Independent contractors make quarterly estimated tax payments to decrease the amount they owe when it comes time to file.
How Do I Calculate My Estimated Tax?
Any independent contractor can calculate their estimated tax using Form 1040-ES from the IRS.
This form lets you input information like your:
- Adjusted gross business income
- Taxable income
- Business deductions
When you input the numbers correctly, you will be able to calculate your specific amount.
You don’t need to send this worksheet to the IRS. However, you should store it in your business records so you can revisit it if needed.
When Do I Pay Estimated Taxes?
When it comes to estimated tax, you can think of the tax year as divided into 4 payment periods. For most years, the four payment dates will be April, June, September, and January (all fall on the 15th).
You can send your payments to the IRS using Form 1040-ES. Some independent contractors choose to pay by mail. Others prefer to pay online or on their mobile devices using the IRS2Go app.
If you don’t like the four-payment period timeline, you don’t have to follow it. You can make estimated tax payments on a weekly, bi-weekly, or monthly basis. As long as you’ve paid enough by the end of the current quarter, you will be in good standing with the IRS.
Not sure how much you owe? Luckily, you can use the Electronic Federal Tax Payment System (EFTPS) to check your payment history. Log onto the EFTPS to view how much and when you made your last estimated tax payments.
What Happens If I Underpaid My Estimated Tax?
Some people think that the IRS only goes after people who avoid their tax returns altogether.
Don’t be fooled. The IRS can, and will, penalize your business if you underpay your estimated tax payments.
Underpaying at the federal, state, or local level can cut into your earnings. The IRS may change the underpayment penalty rates from year to year. They tend to hover around 2% for owed amounts over $1,250.
Most independent contractors will avoid this penalty if they:
- Owe no more than $1,000 on their tax return
- Paid 100% of the tax shown on their tax return in the prior year OR paid at least 90% of the tax in the current tax year (whichever amount is smaller)
What If I Can’t Make Payments on Time?
Some independent contractors may come across issues with making payments on time. This is most often because they don’t receive consistent income.
If you receive uneven income throughout the year, you are not alone. For example, a vegetable farmer may have certain growing seasons where he is more profitable.
If you experience an unequal distribution of income throughout the year, you can lower or avoid penalties altogether. You’ll have to use the annualized installment method, which will redistribute your tax payments.
The IRS may also waive penalties if:
- You failed to make estimated payments because of an unusual circumstance like a disaster or casualty
- You retired (after turning 62 years old) or became disabled during the applicable tax year (the underpayment must have been due to a reasonable cause and not willful neglect)
The Bottom Line
Working as an independent contractor offers you a lot of freedom. You get to choose the work you want to complete and get it done on your own terms.
However, a tax return for a self-employed contractor is a little more complicated than that of a regular employee.
We’ll leave you with three tips:
- Educate yourself: Eliminate any confusion by becoming as knowledgeable as possible. Understand the differences between a Form 1099-MISC and a Schedule C Form 1040. Even if you have a tax professional help you, it’s still wise to have a basic understanding of the filing process. While this guide should have given you a good foundation, never stop learning. Visit the IRS’s official site for more information. You can get details specific to your state and nature of work.
When you understand how the filing process works, you can take better advantage of available credits and deductions. You’ll be able to file with ease, avoid unnecessary penalties, and lower your overall liability. Start filing as a self-employed independent contractor with confidence!