The Complete Guide to Independent Contractor Taxes
Working independently as a sole entrepreneur, freelancer, or contractor implies that you get paid as an independent contractor. IRS says an independent contractor is someone who takes on a project from someone else and performs on it in their own specific ways. This means, that someone who hires you to perform a task, a service, or to provide a service only has a say in the final result and not in the process.
An independent contractor is naturally not a full-time employee, thus you get paid in different ways. You get paid in the name of your business and you pay yourself from your business. Yes, this absolutely means you are self-employed. With self-employment, you get a million responsibilities, and paying your taxes the right way is a major one.
A full-time employee receives their salary after tax reductions, Medicare, Social Security Charges, and other charges if there are any. Since you are self-employed or as we call it, an Independent contractor, you are in charge of paying you are your business’s taxes.
This all can get a little tricky to understand, perform, and pay taxes. Thus this article has everything that you need to know, understand, and finally get done with the process. Let’s see how it works.
What will you find in this article -
- Who is an Independent Contractor?
- Sole Proprietorship
- As an LLC
- As an S Corporation
- How Paying Taxes as an Independent Contractor is Different from Paying Taxes as an Employee?
- How does an Independent Contractor Pay Taxes?
- Self Employment Income and deductions have to be shown on Schedule C
- Self – Employment Tax to be Filed on Schedule SE
- Estimated Taxes to be Paid Quarterly
- No W-2 form, Instead 1099-MISC
- What Tax Form Does an Independent Contractor Use?
- Form 1040
- Schedule C
- Schedule SE
- Form 1099-MISC
- Special Considerations to Make When Paying Taxes as an Independent Contractor
- Understanding Independent Contractor Taxes with Example
- Tips for Navigating Tax Season you Need?
- Key Takeaways
Who is an Independent Contractor?
Independent contracting is a term used for people who are offering their services to others but not as an employee. These services are mostly on a contract basis or on a freelance basis. As per a report generated by Wall Street Journal, an independent contractor makes 30% more money in comparison to a full-time employee for the same amount of work. This report can be a great motivator for you to start as a self-employed person. If you have already started as a self-employed person, you need to understand if you will be considered an Independent Contractor or not. To see it through, here are some of the professions that can be in the same category of being an Independent Contractor.
- Hairstylists
- Carpenters
- Virtual assistants
- Nail technicians
- Writers
- Mechanics
- Therapists
- Landscapers
- Personal trainers
- Doctors
- Attorney
- Accountant
- And a lot more
No matter what your profession is, the government will see you as an Independent Contractor if you are working in any of these ways:
Sole Proprietorship
Sole proprietors are working individual who pays taxes for their business as well as self-employment tax individually. This is done through your personal tax returns as a tax-paying practice.
As an LLC
To be able to access a legally approved tax payment system that differentiates between personal assets, business assets, and business expenses, an independent contractor can choose to shift from a sole proprietorship to a Limited Liability Company (LCC).
As an S Corporation
Once a business entity is registered as an LLC, it can opt for a tax classification that is distinct like an S Corporation. This helps the business owner to escape from paying corporate income taxes which in turn helps in saving more from business profits.
Paying taxes as an Independent Contractor depends on the structure of your business. Let’s understand more about it in detail. Keep reading the article.
How Paying Taxes as an Independent Contractor is Different from Paying Taxes as an Employee?
If you are someone who has never filed their taxes or who is just starting out as an Independent Contractor after working as an employee, it is a must for you to know that paying taxes in both cases has a lot of difference. When an individual is working as an employee and the income is paid as salary by the business, filing taxes is taken care of by the business. The salary is credited to the employee's account after deduction of income tax, Social Security tax, and Medicare tax. The employer is supposed to withdraw half the amount of Social Security and Medicare taxes from the employee’s salary and the remaining half is paid by the business or the employer.
Here are some more major differences between paying taxes as an independent contractor and paying taxes as an employee.
- To put out the right information related to the income of an employee as well as an independent contractor, both have to fill out Form 1040. However, an independent contractor has to file or a self-employed person has to file Schedule C of Form 1040.
- An independent contractor needs to have a bookkeeper or an accountant as they have to pay their own taxes. Independent contractors pay self-employment tax as they do not have to pay Medicare and Social Security Taxes.
- Another major difference between the two is the schedule of filing taxes. An independent contractor has to file the tax 4 times a year in every quarter. The annual tax is divided into 4 payments on estimated income throughout the year. The employed individuals only file income tax once a year.
How does an Independent Contractor Pay Taxes?
Paying taxes as an independent contractor can be tricky. There are multiple forms, and documents you need to file along with estimating the annual income before the income is actually made. This can be done depending on the last financial year's income or based on the estimation through targets on the business model.
Here are some specific things an independent contractor has to know about before filing taxes.
- Self Employment Income and deductions have to be shown on Schedule C.
- Self – Employment tax to be filed on Schedule SE.
- Estimated taxes to be paid quarterly
- No W-2 form instead 1099-MISC
Self Employment Income and deductions have to be shown on Schedule C
An employed individual does not have to worry about filing their taxes. On the other hand, the process is different for a self-employed person. An independent contractor is supposed to use Schedule C to file their taxes. With Schedule C, you will be able to analyze the profit and loss of the business. Along with the tax from business, as an independent contractor, you also have to file a personal income tax return. The Schedule C form is what helps and is to be used.
As an independent contractor, you have to pay self-employment taxes which are higher than the amount of tax a traditional employee pays. Here is the bonus for you. An independent contractor is a self-employed person who is running a business. This way, you can file for a business deduction (expenses) that reduces the amount of profit the business makes to reduce the tax amount.
There is a list of expenses that the independent contractor can claim as a business deduction. The list included expenses like health insurance, phone bills, home office expenses, etc.
Self – Employment Tax to be Filed on Schedule SE
Let’s get it straight, self-employment comes with the freedom to work, massive opportunity for learning and growth, and a huge potential for revenue generation. But there are drawbacks as well. One of these major drawbacks is filing self-employment taxes. Self employment is almost equal to the amount of taxes an employed person files as Medicare and Social Security taxes but there is a difference. While for an employed person, the amount of tax is paid in half by the employer but a self employed person has to file the self employment taxes on their own in full amount.
But wait, there is a good side too. Yes, you have to pay the entire amount of self employment tax by yourself, but you can also cut down your taxes with deductions. The deductions can easily be as much as half the amount of the tax you have to pay. Isn’t that great? Currently, the self employment tax rate is 15.3% of your income.
Estimated Taxes to be Paid Quarterly
The tax amount you file goes straight to the government. Of course, the government needs a constant flow of money coming in to run the country. This is why the US government demands 4 quarterly payments of your tax amount. Now as an employee, the tax amount is cut by the employer each month before the salary is credited. The employer then files quarterly taxes with the same.
As a self employed person, you yourself have to take care of filing the tax. How is it done? It is simple. All you have to do is make quarterly installments of the final amount of tax to be filed. Yes, the tax amount is estimated on an assumed amount of revenue or profit the business might make in the f9inancial year. If you have already filed your taxes the previous yes, take estimates from the last filed tax amount.
The estimated payment has to be a fair amount. If you underpay your taxes, the government can file a case against you and you might have to pay penalties. Also, the tax is paid to both the central government as well as the state government.
No W-2 form, Instead 1099-MISC
As an employee, at the end of the year, the W-2 form helps you understand the amount of money you made throughout the year. It helps you locate and understand your salary and the amount of tax being withheld from your salary.
A self employed person needs the same kind of clarity as well. A self employed person receives 1099-MISC. The form has all the details of the revenue generated and profits made. This also makes it easier for the self employed person to keep in sync with their books.
A self employed person or an independent contractor only receives 1099-MISC when the revenue generated from one client during the year exceeds $600. If this does not happen, the independent contractor will have to file a Schedule C form.
What Tax Form Does an Independent Contractor Use?
IRS has a ton of forms when it comes to filing taxes. Every single form has a specific task and need. Of course, as an independent contractor, you do not have to understand or learn about all of them. Here are some of the forms that you need to know about when it comes to filing your taxes as an independent contractor.
Form 1040
Form 1040 is a form for both employed and self employed individuals. The form is submitted at the end of each year with all the details specifying the gross income, tax amount to be paid, and the refunds that can be claimed.
Schedule C
The schedule C form has to be filed along with Form 1040. Independent contractors, LLCs with a single owner, or sole proprietors are supposed to file this form. The form demands details of income, business records, stock for the business, and expenses.
Schedule SE
To analyze the amount of your employment tax based on the net income of that particular year, the independent contractor has to file the Schedule SE form along with Form 1040. Yes, this form is only applicable to self employed individuals.
Form 1099-MISC
Form 1099-MISC is not a form that you file but a form that you receive from each individual client you have worked with and generated a revenue of more than $600. The form helps you with details of revenue to heck and maintains your books right. It also helps you fill in the correct information to fill in the Form 1040 and Schedule C form that goes to IRS.
Special Considerations to Make When Paying Taxes as an Independent Contractor
The process of tax filing begins with filling out the documents, right? Absolutely not. The process of tax filing being with taking in the right information that you require while doing the paperwork, taking out the estimated tax, and finally filling the amount. Here are some special considerations you have to keep in mind when you are filing taxes as an independent contractor.
1.
There is a set threshold when it comes to paying taxes. The government has set a minimum amount of revenue, if you make that much or more than the set amount, only then a person of a company is required to pay taxes. For an independent contractor, if your annual revenue is equal to or more than $400, only then you are liable to pay taxes.
2.
The deductions that can be claimed for business purposes have a list approved by the government. As we discussed, these deductions are nothing but expenses that takes to run a business.
- Travel, stays, meals
- Marketing expenses
- Business meetings
- Charges for commute or fuel
- Office rent
- Property tax amount if you have a home office
- Retirement plan premiums
- Business insurance plan premiums
- Phone and Network bills
- Cost of Equipment purchased
- Legal expenses
3.
Another consideration to take into notice is the Medicare surtax. If an Independent contractor makes more than $200,000 annually and files their taxes as a self-employed individual or the head of the family, they have to pay 0.9% of the surtax.
Understanding Independent Contractor Taxes with Example
Mark is an independent contractor who has worked with two clients in the financial year. He made $40,000 in revenue from both clients in total. At the end of the year, Mark receives Form 1099-MISC from both of his clients since the revenue made from each is above $600. Mark attached both the forms in Part 1 of the Schedule C form he had to file.
Even though Mark is an independent contractor, his business is treated as a separate entity. He made a couple of work trips that cost $500. He also had a home office that is spread over 100sq feet. Taking $5 per square foot, it becomes a total of $500. Here, the business expenses are $1000 and it will be treated as a deduction.
Mark also traveled for 600 miles in the car for a work requirement. IRS allows a $0.58% of deduction on each mile which makes it $348 in total. Now adding up all the deductions it will come to a total of $1,348. Remove the deductible amount from the revenue made, and it will be $38,652. Now, the net profit Mark mentioned on the Schedule C form is $38,652. On Form 1040 Mark will mention the original revenue amount as his taxable income.
Mark has clear revenue information in hand. Accordingly, he is supposed to file his payable tax amount using Schedule SE. The amount calculated with Schedule SE’s help is $5,914. Half of this amount of tax which becomes $2,947 has been taken as a deduction on page 1 of the Form 1040.
Here is all the information on payable tax and deduction that mark had to file in the forms.
When you go about filing your taxes, this live example can be followed and taken help from. However, it is always wiser to take advice from an accountant or your bookkeeper before you file your taxes.
Tips for Navigating Tax Season you Need?
Track Your Expenses and Income – As an independent contractor; you are in charge of everything, including tracking income and making expenses. While dealing with millions of other things, keeping a track of them can be tough. For the same, Deskera can come in handy. You can create invoices, track payments, record income, and keep your books updated with Deskera. Your bookkeeper can then use the data at the end of the year to check and estimate the amount of tax to be paid. When kept track from the beginning, filing and estimating taxes automatically becomes a lot better and hassle-free.
Save Your Income to File as Tax – As an Independent Contractor, all the money you make goes straight into an account that you control independently. Make sure you do not take all the money you generate in revenue as your income. As soon as you receive your paycheck, keep 25% of it in a different account. This way, you will have your tax amount saved right from the beginning of the financial year The leftover amount from this saved amount at the end of the year can be treated as a bonus for the business as well.
Set a Strategic Payment Plan – Working with a strategic plan always brings in better results. Begin right at the start of the year. Plan out how much you target to make as revenue in than financial year and how much you estimate the taxes to be. Take this estimation and start paying your taxes accordingly quarter wise. Make sure you plan the tax payments according to the IRS schedule. The last day to file your taxes is the 15th of April mark it on your calendar.
How Deskera Can Assist You?
As a business, you must be diligent with the employee payroll system. Deskera People allows you to conveniently manage payroll, leave, attendance, and other expenses. Generating payslips for your employees is now easy as the platform also digitizes and automates HR processes.
Key Takeaways
Filing self employment taxes may sound like a complicated task but it really is not. We have covered everything you need to know about self employment taxes in this article So rather than worrying about it, all you have to do is give the article a read and you will be all set. Still, thinking it is a lot to ask? Alright, here are some of the most important takeaways from this article that are a must to know.
- Self employment taxes or filing taxes as an Independent contractor is different from filing taxes as a traditionally employed person. You have to do it all on your own, by the income you are making from your business and not your job.
- Before filing the taxes as an independent contractor, it is important for you to learn about all the forms that you will be required to fill in the process.
- Independent Contractors pay self employment taxes on an estimation of the yearly earnings from their business. The tax is paid in 4 installments, once in each quarter as per IRS’s schedule.
- An Independent contractor is only supposed to pay self employment taxes if their annual income is more than $400 in total.
- You can save a lot on your payable tax amount by showing deductions. Business expenses are called deductions and the government lets you deduct some specific business expenses from your revenue, thus decreasing the amount of payable tax.
- Independent tax is not filed on a fixed amount of revenue made. It is filed on an estimation of the revenue the business is going to make in the financial year.
- The tax amount is then filed in 4 installments, once in each quarter.
- Yes, you can file your tax on your own but make sure you hire an accountant or a tax consultant to eliminate all the mistakes