This handy guide for independent contractors explains tax responsibilities, deadlines, deductions and how to pay.
Updated Oct 15, 2020 · 6 min read Written by Erica Gellerman, CPA Erica Gellerman, CPA
Erica Gellerman is a tax specialist, financial writer and educator. She holds a California CPA license. Her work has been featured in Forbes, Money, Business Insider, WealthFit, Accounting Today, LendEDU, CreditKarma and more. She has an MBA from Duke University and a degree in business economics from UC Santa Barbara.
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MORE LIKE THIS Small-Business Taxes Small BusinessPaying business taxes as an independent contractor can be tricky. You have to file additional forms, make sure you’re paying the government enough during the year and pay a self-employment tax.
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Annual FeeHow does a business determine whether you are an independent contractor or employee? The IRS has rules and tests to help make the decision, but at a high level, if a business only has the ability to control the result of the work you perform, not how you perform the work, you might be considered an independent contractor.
If you are an independent contractor, the IRS considers you to be self-employed — you aren’t an employee of any company. As an independent contractor, you can operate as a sole proprietor , a limited liability company (LLC) or an S-corporation. The majority of businesses in the U.S. are run as sole proprietorships, so we’ll focus on that structure in this article.
Things get a little more complicated with your taxes when you’re an independent contractor. You’ll have additional forms to file and you’ll need to file estimated taxes regularly. There are four main differences between filing taxes as an employee and filing taxes as an independent contractor. These include:
Reporting self-employment income and deductions on Schedule C. Paying self-employment tax on Schedule SE. Paying quarterly estimated taxes. Receiving form 1099-MISC rather than a W-2.How you report the income you earn as an independent contractor is different than how you’d report it as an employee. As an independent contractor, you’re required to file Schedule C along with your personal tax return. Schedule C details your profit and loss from business.
Remember that an independent contractor is considered to be self-employed, so in effect, you are running your own one-person business. Any income that you earn as an independent contractor must be reported on Schedule C. You’ll then pay income taxes on the total profit.
While being an independent contractor means you have to pay more in self-employment taxes, there is an upside: You can take business deductions. These business deductions reduce the amount of profit you pay income taxes on.
You’ll report these deductions along with your income on Schedule C.
There are a number of business deductions you can take as an independent contractor, including health insurance, home office deductions, mileage and deductions for your phone bill.
The Tax Cuts and Jobs Act also created another deduction that some independent contractors may qualify for: the qualified business income deduction. This may allow you to deduct up to 20% of your business income.
A big financial drawback of self-employment is paying self-employment taxes. These taxes are equivalent to the Medicare and Social Security taxes you’d pay as an employee. But as an employee, your employer covers half the cost of the taxes. As a self-employed person, you’re required to pay the entire tax yourself.
And these self-employment taxes really add up. The current self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare — a total of 15.3% just in self-employment tax. The good news is that while you need to pay the entire 15.3% tax, you can take half of what you pay as a deduction from your income.
You’ll report self-employment taxes by filing Schedule SE with your personal tax return. These taxes are in addition to any income tax that you’ll owe.
The U.S. tax system is a pay-as-you-go tax system, meaning you need to make tax payments regularly throughout the year. When you’re an employee, your employer is responsible for withholding income taxes from your paycheck and sending it to the government.
So, how does an independent contractor pay taxes? When you’re an independent contractor, paying the government regularly throughout the year is your responsibility. You do this by making quarterly estimated income tax payments. You can estimate how much you need to pay the government each quarter by guessing what your total income for the year will be or by using the amount you’ve paid in estimated taxes the previous year.
You won’t know exactly how much tax you owe until you file your personal tax return at the end of the year. But you’ll want to spend time estimating this because if you underpay your estimated taxes, you could be subject to penalties.
And don’t forget to pay estimated taxes to your state. Aside from making federal estimated income tax payments, you’ll be required to pay your state throughout the year as well.
As an employee, you receive a W-2 each year detailing how much you made and how much you had withheld from your paycheck for taxes.
Instead of a W-2, as an independent contractor, you’ll receive a 1099-MISC. This form details how much you were paid throughout the year. You can use that information to double-check that you’re reporting all of your income earned through the year.
If you earned less than $600 from a client during the year, you won’t receive a 1099-MISC, but you will still need to report that income on your Schedule C. That’s why keeping a good accounting system is so important.
As an independent contractor, be prepared for additional tax deadlines. Now, in addition to your personal income tax deadline of April 15, you’ll also have both federal and state quarterly tax deadlines.
Your estimated tax payments are due four times per year. You can use Schedule SE to help you calculate how much you owe at each deadline.
The deadlines for making your quarterly estimated tax payments are:
April 15: for income earned from January through March. June 15: for income earned in April and May. Sept. 15: for income earned from June through August. Jan. 15: for income earned from September through December in the prior year.Don’t forget that if your state has income taxes, you’ll also need to make estimated tax payments to your state. Check with your state’s business resources for deadlines and any required forms.
Your personal income tax deadline as an independent contractor is the same as it is for employees. All personal income tax, filed with Form 1040, is due April 15 of each year. If April 15 falls on a weekend or a holiday, they are due the next business day.
With your Form 1040, you’ll file your Schedule C, Profit and Loss from Business and your Schedule SE, Self Employment Tax.
If you can’t file your taxes by the April 15 deadline, you should use Form 4868 to file for an automatic six-month extension. But that’s only an extension to file your paperwork — if you owe any taxes, you’ll need to pay them by the April 15 deadline to avoid being charged a penalty.
If your state has income tax, you’ll also be required to file and pay your state income taxes. Check with your state to understand when and how to pay state taxes on your income as an independent contractor.
So, how does calculating your own independent contractor taxes work?
Let’s say during the year you earn $40,000 as an independent contractor from working with two companies. These are your only jobs and you’re not an employee anywhere else. You should receive a 1099-MISC from each company confirming how much they paid you during the year. You’ll include this income on Part 1 of your Schedule C.
You also have some expenses that you can deduct from your income. You work from a qualified home office, which is 200 square feet — and using the simplified method, you can deduct $5 per square foot. Your home office deduction is $1,000.
You also drove 600 miles during the year for some required assignments, so you can take a deduction of $348 (using the IRS deduction of $0.58 per mile ). In total, you have $1,348 in deductions so the total net profit as an independent contractor that you report on Schedule C is $38,652. That income amount will be included on Form 1040 as your taxable income.
Once you know how much you earned, you’ll need to figure out how much you must pay in self-employment taxes. Using Schedule SE, you calculate that you owe self-employment taxes of $5,914. Half of this tax that you pay ($2,957) is taken as a deduction on Page 1 of your Form 1040.
Now that you’ve completed your Schedule C and Schedule SE, you have the income and deduction information you need to finish filing your 1040 personal tax return.
A version of this article was first published on Fundera, a subsidiary of NerdWallet
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