Paying business taxes as an independent contractor can be challenging because of the different tax rules and additional forms you need to fill out. Whether you are a 1099 worker or an Airbnb host, you still need to report your self-employment income. Things can get a little bit complicated in filing your taxes as an independent contractor, so it is important to learn how the tax system applies to independent contractors.
After all, understanding the rules for paying business taxes as an independent contractor helps you avoid getting slapped with fines by the Internal Revenue Service (IRS).
Understanding Independent Contractors
An independent contractor is a person who works for someone else but not as a traditional employee. A traditional employee works for a business under any contract of hire, and it is the employer who directs how to perform the work. An independent contractor works in a different capacity.
And unlike an employee, an independent contractor is generally considered self-employed. The IRS defines an independent contractor as a person offering services to the general public. You don’t consider yourself an independent contractor if someone else dictates your work and your work process.
According to a report, 79% of independent contractors prefer their work arrangement over a traditional job. While contractors don’t enjoy some aspects of traditional employment, such as stability of pay and benefits, they realize the satisfaction from using their strengths and greater autonomy.
What Is the Difference Between an Independent Contractor and Self Employed?
An independent contractor is considered self-employed. Examples of self-employed workers include freelancers, store owners, gallery artists, or founders of a company. According to the Bureau of Labor Statistics’ 2017 Contingent Worker Supplement (CWS), the independent contractor still remains the largest alternative employment arrangement.
Now, the difference between an independent contractor and a self-employed person is minimal. The independent contractor is only a category of self-employed. 44 million workers were self-employed at some point in 2019, while 14% of these workers said their primary job was being an independent contractor. These workers represented 28.2% of the U.S. workforce.
Who Qualifies as an Independent Contractor?
The main characteristic of all independent contractors is their control over their work. Many careers work under this setup as independent contractors, such as doctors, accountants, hairstylists, freelancers, electricians, dentists, attorneys, lawn care providers, and many more.
This status applies irrespective of the business’ structure. Whether you operate as a sole proprietor or a corporate structure, you can still be considered an independent contractor – for as long as you don’t belong to the employee classification.
Additionally, if you run a business and hire people, you decide whether you classify them as employees or independent contractors. Worker status is significant because incorrect classification may trigger tax penalties. According to the IRS, you classify workers as employees if their work and how it’s done are controlled by the person who pays them. And when your workers are classified as employees, you are required to provide benefits as part of the overall compensation package.
How Do You Pay Taxes as an Independent Contractor?
The IRS classifies an independent contractor as a self-employed individual for tax purposes, which means they’ll be subjected to a set of tax payment rules different from that of a traditional employee. If you are an independent contractor, here are some of the things you need to know about how to pay your taxes.
Report Your Self-Employment Income as an Independent Contractor
Reporting earned income is different if you were an employee. Independent contractors need to file Schedule C, which details their business profits and losses, along with their tax returns.
Since independent contractors are self-employed individuals. This means they run their own ‘one-person’ business. So, all income must appear on Schedule C. Afterwards, they have to pay the overall profit’s taxes. According to a September 2021 report, the average hourly income of an independent contractor in the U.S. is $26.93/hr, and the highest paying related independent contractor job is truck drive owner/operator, with an annual salary of $157,601.
Expenses You Can Deduct
You can make use of deductions if you wish to lower your annual taxable income. As an independent contractor, you can claim these as your business expenses on your taxes. Depending on the type of business you run, some of these deductions may include:
- Marketing and advertising expenses
- Business insurance
- Legal expenses
- Vehicle-related and travel expenses
- Home and office expenses
- Other equipment purchases
You have to file these on your Schedule C, together with your income.
Additionally, you can deduct your personal expenses, such as real estate taxes, interest on student loans, and mortgage interest. Getting a tax break for contributing to a traditional individual retirement account (IRA) or self-employed retirement plan also can offer some benefits.
The Trump Tax Reform Plan, also known as the Tax Cuts and Jobs Act (TCJA), allows qualified independent contractors to deduct 20% of their business income when filing income taxes.
Report Self-Employment Taxes
One of the significant drawbacks of being self-employed is dealing with self-employment taxes. These taxes include Social Security and Medicare. The advantage of being an employee is that half of your costs are covered by the employer. But if you’re self-employed, you have to pay both the employee and employer contributions.
Currently, self-employment tax rates for Social Security and Medicare are 12.4% and 2.9%, respectively. This totals 15.3% just for your self-employment tax. But the great news is, while you have to pay this amount, half of this can be used as a deduction from your annual income.
Report your self-employment taxes by filling out Schedule SE with your tax return. The Schedule SE calculates the amount you need to pay in Social Security and Medicare, while the income and loss on Schedule C calculate how much you owe in overall taxes.
Quarterly Estimated Taxes
The tax system is pay-as-you-go, which means you have to make most of your tax payments as you receive your income instead of paying them at the end of the year. For employees, it’s the employer’s responsibility to remit their income taxes to the government. But for independent contractors, it is their responsibility to submit payments throughout the year.
Individual contractors do this through quarterly estimated tax payments. They estimate this amount by determining their total annual income. Or using the previous year’s estimated taxes. Until you’ve filed your tax return at year-end, you won’t know the amount of taxes you owe for the year. Make sure to spend some time assessing this because underpaying your taxes could subject you to penalties. Additionally, make sure you pay state taxes throughout the year on top of your federal tax payments.
Receiving Form 1099-MISC
Employees receive a Form W-2 annually, and this form details how much they made and the amount withheld from their income for taxes. However, independent contractors receive a Form 1099-MISC rather than a Form W-2. Form 1099-MISC shows how much you’ve paid throughout the year. Using the information in this form, you can verify if you’ve reported your income correctly.
You can only receive a Form 1099-MISC if you earn at least $10 in royalties or $600 in other types during the tax year. If your income is less than this amount, you still have to report it on Schedule C. So, it’s necessary to have records to account for these considerations.
What Are the Due Dates for Estimated Taxes?
The due dates for the quarterly estimated tax payments are the same each year:
- April 15 – for the 1st Quarter (January – March)
- June 15 – for the 2nd Quarter (April – May)
- September 15 – for the 3rd Quarter (June – August)
- January 15 (the following year) – for the 4th Quarter (September – December)
If the day is a weekend or a holiday, the due date becomes the next weekday.
The deadline for personal income tax is also the same for employees, which is due every April 15 annually. If it’s a weekend or a holiday, the due date is moved to the next weekday. With Form 1040, you have to file the following:
- Schedule C
- Schedule SE
- Profit and Loss from Business
- Self-Employment Taxes
If you don’t make it by the deadline, you need to get Form 4868 to file an automatic 6-month extension. However, this is only to extend the processing of your paperwork. You still have to pay your taxes by the deadline. Otherwise, you’ll be subject to fines and penalties.
State income taxes vary by state. Verify with your state on when to make tax payments or whether it is required to do so.
How to Pay Estimated Taxes Online?
You can pay your estimated taxes wherever you are through the IRS website. If you pay online, IRS receives it almost immediately, and there is also a system-generated confirmation number for payment made. So, you won’t run into problems like receipts getting lost in the mail.
Taxes: Independent Contractor Example
Take a look at this example to help you understand how taxes work if you’re an independent contractor. Remember, your situation may be different. So, consult your tax professional to help you prepare your documents.
Suppose you only work with one company. During the year, you earn $10,000, and the company must provide you with a Form 1099-MISC detailing how much you’ve made. This income must appear on your Schedule C.
You can also deduct your expenses from your income. If you are working on a 150-square foot home office, you can deduct $5/sq. ft. As a result, your home office expense is $750. Assuming you no longer have other expenses, your total deductions are $750. Your total net profit is $10,000 – $750 = $9,250. This amount should appear as taxable income on Form 1040.
Afterward, you also have to figure out your self-employment tax payment using Schedule SE. Once you’ve completed Schedules C and SE, you now have the necessary information to finish filing your Form 1040.
Filing your taxes as an independent contractor can get complicated. You might consider working with a tax professional to help you manage your income and taxes. It’s also helpful to develop a good accounting system to ensure you accurately record your annual income and expenses. The process may be overwhelming, but you can achieve your financial goals as long as you figure out your taxes.