There are plenty of independent contractor jobs available today. An independent contractor is their own boss and has complete freedom to take up any project they want. But do you know where things get complicated?
When it comes to the independent contractor taxes. In this article, we have covered everything about independent contractor taxes and deductions. So, let’s get started.
First Thing First, Who is an Independent Contractor?
As a business owner, how do you classify an independent contractor? According to the IRS, an independent contractor or freelancer is self-employed and is not an employee of any particular organization. An independent contractor can function as a sole proprietor or as a Limited Liability Company (LLC).
How Is Independent Contractor Income Paid and Reported?
The payroll structure of an independent contractor is completely different from that of a full-time employee. You can pay an employee on a consistent schedule. This can be weekly, bi-weekly or monthly. On the contrary, when it’s about paying the independent contractors, it’s all between the employer and the contractor to decide the payment terms. For instance, it is up to you and the contractor on how you’ll make their payment. It could be via PayPal, bank transfer, or any other mode that suits you both.
These payments you make to the independent contractors are neither salary nor wage. That’s because the vendor doesn’t deduct taxes on these. Hence, when a freelancer receives the payment before deducting any federal taxes or social security taxes. However, a freelancer should be mindful of the mode of payment. That’s because gateways like PayPal charge separate fees on every transaction.
Then, how does filing taxes as an independent contractor work? Well here are the steps:
- When it is the income tax filing season, the employer will send the contractor a 1099-MISC form. The purpose is to report all their incomes from the previous year. The full-time employees, on the other hand, receive a W-2 form to report the same.
- There’s an exception here. Suppose, the independent contractor earned less than $600 in a particular tax year. In that case, the payer doesn't need to send a 1099-MISC form. However, the independent contractor is still required to report their income.
- For freelancers working on multiple projects simultaneously, you’re very likely to receive multiple copies of the 1099-MISC form each year. Employers must complete this process by the end of January every year.
How does an Independent Contractor Pay Taxes?
We won’t lie here! The independent contractor tax filing process is indeed complicated. The freelancer’s job is to track their incomes daily and fill up additional forms as per requirement. Here are the things you should know about:
- Reporting the self-employment income
Reporting self-employment income is different from that of a regular employee. Independent contractors are required to file Schedule C along with their tax returns. In Schedule C, independent contractors detail their profits and losses from the business.
Remember that independent contractors are self-employed, and they are running a business. So, any income earned by an independent contractor must be reported on Schedule C. Then, they pay the income taxes on their total business profit.
- Deductions on Schedule C
Typically, independent contractors pay more in self-employment taxes. But the good news is that they can take business deductions. These deductions reduce the profit amount on which they pay their income taxes.
Along with incomes, independent contractors are required to report their deductions on Schedule C. In the case of independent contractor taxes, there are several deductions such as home office expenses, health insurance, travel-related expenses, mileage, and even phone bill deductions. Further, there are also qualified business income deductions that can also reduce up to 20% of the income earned.
- Self-employment taxes payment
Filing taxes as an independent contractor include paying self-employment taxes. This is similar to employees paying Medicare and Social Security taxes. The only difference is that employers cover half the tac cost in the case of employees. But independent contractor taxes must be paid by the individual alone.
Currently, the self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare. Thus, it is a total of 15.3% in self-employment taxes. Thankfully, independent contractors can take half of what they pay as a deduction from their income.
Independent contractors report their self-employment taxes by filing Schedule SE in addition to their tax returns and any income taxes owed.
- Payment of quarterly estimated taxes
As an employer, you must pay the taxes regularly throughout the year. You must withhold income taxes from your employee compensations and send them to the government.
What about independent contractor taxes?
Independent contractors are responsible for paying their own taxes regularly. They often do it by estimating the quarterly income tax payments. That means independent contractors estimate how much should be paid as taxes quarterly by predicting the total annual income.
Independent contractors can use the previous years' taxes for guessing the estimates. Though they won’t know the exact tax amount until year-end, estimating it will prevent underpaying.
Independent contractors also make it a point to estimate state taxes along with federal income taxes because underpaying, in any case, might lead to penalties.
- Receiving 1099-MISC
Independent contractors receive 1099-MISC instead of W-2 that is for employees. In this form, independent contractor incomes are detailed.
Independent contractors can use the 1099-MISC details for verifying their reported income earned throughout the year.
However, note that independent contractors do not receive 1099-MISC if they receive less than $600 from a client annually. But the income will be reported on Schedule C. Hence, the importance of a good accounting system for independent contractors is pretty straightforward .
One benefit of filing taxes as an independent contractor is that they get several deductions. These tax deductions reduce their taxable income.
Here’s a list of the tax deductions that they can claim as business expenses.
- Educational costs – Pursuing a course or further studies might be significant for business growth. In this case, independent contractors can claim webinars, conferences, meetings related expenses as tax breaks.
- Home office expenses – Suppose an independent contractor uses home office space (like home space used as a yoga studio or to stock inventory). Here, several costs like repairs, renovation, utilities, etc., can be claimed as deductions under this category.
- Rent or lease payments – Rented space, equipment, or leased property for business is a tax write-off.
- Business Insurance – Independent contractor deductions include all costs related to business insurance coverage.
- Equipment purchase – Independent contractors can claim equipment purchased for business as a tax deduction. For example, a printer purchased for business purposes.
- Vehicle-related costs – An independent contractor using a vehicle to make deliveries or attend business meetings can claim the vehicle-related expenses as deductions. Car expenses and mileage can add up to tax write-offs.
- Advertising expenses – Expenses related to digital and traditional promotions like posters, flyers, website design, maintenance, etc. come under tax deductions.
Besides, an independent contractor can also deduct personal expenses like mortgage interest payment, interest paid on student loans, and property taxes. Plus, contributions towards a self-employed retirement plan or traditional IRA can also get them a tax deduction.
Independent contractors can also claim a tax break for health insurance premiums. It includes dental, medical, and long-term care insurance. If the contractor pays spouse’s and children’s insurance, the costs can also be claimed as deductions. However, if independent contractors have access to their spouse’s insurance plan, they cannot deduct health insurance premiums.
Independent Contractor Tax Deadlines
Independent contractor tax deadlines are a horror.
Because they have the additional federal and state quarterly tax deadlines along with personal income tax deadlines. It seems independent contractors will have to set reminders for taxes!
Quarterly Estimated Tax filing
Quarterly taxes are due four times annually. Independent contractors can use Schedule SE to calculate the taxes owed at each deadline.
Here’s the list of deadlines for making the quarterly estimated tax payments.
- April 15: Income earned between January to March.
- June 15: Income earned in April and May.
- Sept. 15: Income earned from June to August.
- Jan. 15: Income earned from September to December in the previous year.
Personal Income Tax deadline
April 15 is the deadline for independent contractor personal taxes filed with Form 1040. Along with 1040, independent contractors need to file Schedule C, Business Profit & Loss, Schedule SE, Self Employment Tax.
In case of deadline failures, use Form 4868 for an automatic six-month extension.
State Tax deadline
For state income taxes, independent contractors need to check the state business resources for deadlines.
Independent contractor taxes working with an example
So, how to calculate independent contractor taxes?
Let’s take an example.
An independent contractor earns $40,000 from working with two firms. The individual receives 1099-MISC from each firm confirming the total annual payment. Part 1 of Schedule C includes the $40000 earned as yearly income.
Independent contractors also get to deduct some expenses from their income. Like, if they work from a qualified home office of 200 sq. ft., they can reduce $5 per square foot. Their home office deduction would be $1000.
Then, the independent contractor drove 600 miles during the year for a few projects. The independent contractor tax deduction would be $348 (the IRS deduction is $0.85 per mile). In total, they will have $1,348 in deductions. Hence, the independent contractor will report $38,652 net profit on Schedule C . Form 1040 will include $38652 as the taxable income.
In the case of independent contractor self-employment taxes, the calculation demands the total income earned. Using Schedule SE, the independent contractor calculates self-employment taxes of $5419. Half the amount- $2957 will be taken as a deduction on page 1 of Form 1040.
After completing Schedule C and Schedule SE, independent contractors have the income and deduction details that they need to complete filing 1040 for personal tax returns.
Tax Tips for Independent Contractors
Well, we might have provided you with most of the details, there’s just one left out.
Here are a few tips and tricks that independent contractors must keep in mind to make filing taxes as an independent contractor less burdensome.
Hiring a finance professional
With all that project deadlines, independent contractors must not risk doing the taxes all by themselves. Hiring a tax professional is a much better idea.
Independent contractors must look for an accountant specializing in their industry. Though there will be the expense of paying them a professional fee, tax consultants will save a lot of time. Plus, they can help independent contractors save thousands of dollars in deductions. So, hiring a professional will result in profits.
Independent contractors will have an easier life with an organized record-keeping system. Calculating the independent contractor taxes becomes seamless. So, they must ensure the accurate recording of all of their incomes and expenses every year.
Qualified business expenses reduce the income on which independent contractors owe taxes. To get the lowest possible taxable income, independent contractors must keep their receipts.
These receipts will help in filing the tax returns. Plus, they will be necessary for claiming deductions.
Independent contractors can also use an expense app to track the receipts from charitable donations and other deductible expenses.
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