How to File Taxes as an Independent Contractor
Independent contractors have the freedom to choose when they work, where they work, and who they work for—but when it comes to taxes, life can get a bit more complicated. Lucky for you, we’ve put together a guide on how to navigate the sometimes murky maze of independent contractor taxes.
What’s an Independent Contractor?
Before you get all nervous about how to pay taxes as an independent contractor, you should first make sure you are one. To determine whether you are an independent contractor, you’ll want to ask yourself a few questions.
- Do I have fundamental power and control over what I do at work?
- Can I choose my clients and set my own contracts?
- Do I determine what tools or equipment are used to do the work?
Basically, if you are performing a service and calling most of the shots, you’re probably an independent contractor.
The term “independent contractor,” refers to the fact that the worker is independent of the client or company they are providing work for, with payment tied to the completion of the job. Independent contractors most often provide expertise and skill in a particular field, rather than a specific product or good.
Filing Taxes as an Independent Contractor
Filing taxes is a lot like baking a cake; you need to start off by assembling all of your ingredients. From there you’ll follow the recipe, and in a few hours you’ve got a nice fluffy dessert—or in this case, an annual tax return. Follow the recipe below for tax filing success.
Taxes can be daunting, which is why it behooves you to get all of of your important paperwork in order before sitting down to fill out your tax forms. It’s like gathering all the ingredients before you turn on the oven. Here’s a basic checklist of what you’ll want to have at the ready in order to fill out your annual tax forms:
- 1099-NEC Forms
Clients who paid you $600 or more will send these to you at the end of the year. You’ll use your 1099-NECs to add up the income that you earned as an independent contractor.
- Copies of 1040-ES Forms
Form 1040-ES is used to calculate and pay your estimated taxes throughout the year on a quarterly basis. You’ll need to report all the estimated payments you made on your 1040.
- Receipts for Business Expenses
Keep track of your receipts throughout the year. These receipts detail the date and time of each transaction you’ve made for your business, and they can also be used to reduce your taxable income.
When you choose to work for a client, they’ll usually ask you to complete a W-9, which is an IRS form that is used to collect your taxpayer information. The W-9 allows your client to maintain accurate records and report any payments made to you for the job you’ve agreed to do.
At the end of the year, clients are required to send you IRS Form 1099-NEC if you rendered services in excess of $600. For the 2020 tax year, the IRS replaced the 1099-MISC form with the 1099-NEC form. This will be the form used going forward to report non-employee compensation.
Companies and clients that use the services of independent contractors must send these forms by January 31st to provide adequate time for the contractor to prepare and file their taxes. If a client fails to send a 1099-NEC, either because your fee didn’t meet the payment threshold, or they just forgot, you are still responsible for reporting the income. This is why it’s important that you keep your own records and receipts throughout the year.
Since withholding and deductions aren’t subtracted from an independent contractor’s income, you’ll need to use specific tax forms and schedules to complete your tax return. The IRS’s Self-Employed Tax Center offers independent contractors links to all the tax forms you’ll need, as well as an abundance of information about the tax filing process.
Form 1040: IRS Form 1040 is the Rosetta Stone of tax forms in that it binds all the tax forms together. The 1040 is used to report your gross income (a.k.a. all the money you made in the past year) as well as how much of that income is taxable after you take tax credits and deductions into account. In short, the 1040 calculates the amount of tax you owe the IRS, or the refund you will receive. Tax returns can get complicated, which is why the IRS has various schedules that you can add to your 1040 to better break down and organize your financial information:
- Schedule C: Schedule C is the form that you use to report self-employment income. Schedule C is where you’ll calculate your business’s net profit or loss in order to arrive at your net business profit or loss, which is then added to your other income on Form 1040.
- Schedule SE: Use Schedule SE to figure out the tax due on your net self-employment earnings. The Social Security Administration uses the information from Schedule SE to calculate your benefits under the Social Security program. Keep in mind that this tax applies to all taxpayers, even if you’re already collecting Social Security or Medicare benefits.
Quarterly Estimated Tax Payments
Independent contractors who expect to owe at least $1,000 in taxes from their self-employed income are required to pay quarterly estimated taxes. Your estimated tax payments are due four times per year. The deadlines for making your quarterly estimated tax payments are:
- April 15th: for income earned from January through March.
- June 15th: for income earned in April and May.
- September 15th: for income earned from June through August.
- January 15th: for income earned from September through December in the prior year.
Don’t forget that if your state has income taxes, you’ll need to make estimated tax payments to your state’s tax board. Our handy dandy guide to state tax rates can be found here, or you can check with the appropriate state tax agency for deadlines and any required forms.
How to Pay Your Estimated Taxes
Use Form 1040-ES to calculate and pay your estimated taxes. Form 1040-ES acts as a worksheet for taxpayers, helping them to calculate and pay estimated taxes for the current year.
There are a number of ways to pay your estimated taxes, but the most popular one is through the IRS’s Electronic Federal Tax Payment System (EFTPS). EFTPS allows business owners to pay estimated taxes in sort of a pay-as-you-go system, with weekly, bi-weekly, and monthly installment options. EFTPS takes the guesswork out of how to keep your business in good standing and aboveboard with the IRS.
You can also pay the IRS in these other ways:
- The IRS2Go mobile app.
- Payment over the phone with debit or credit card.
- Same-day wire through your bank.
- Cash payment at participating location (maximum $1,000 payment per day)
The IRS also accepts mailed returns for quarterly estimated payments. Form 1040-ES will walk you through the process of sending a check or money order to one of three IRS offices, depending on where you live. You’ll need to include IRS Form 1096 if you’re submitting your annual information returns to the IRS by mail. Form 1096 is a summary of all your other submitted 1099s and similar tax forms. It basically acts a cover sheet for these other tax forms.
Are There Penalties for Paying Estimated Taxes Late?
If you miss a quarterly tax payment, the penalties and interest charges that can accrue depend on how much you make and how late the payment is. The IRS typically docks a penalty of 0.5% of the tax owed following the due date. For each partial or full month that you don’t pay the tax in full on time, the percentage can increase. Even if you are a day late, the IRS will penalize you. That’s why it is important to keep up-to-date on all your record keeping.
Independent Contractor Taxes FAQs
What taxes do independent contractors pay?
Being an independent contractor comes with a lot of perks, but it also comes with a different set of tax responsibilities. When you work for a client, you are paid your full fee with no taxes withheld. This means your business will have to meet certain tax obligations in order to remain in the good graces of the IRS. Here’s a quick overview of what taxes you are expected to pay as an independent contractor.
Independent contractors are responsible for paying the same federal income taxes as everyone else, which means they must keep track of their income, estimate how much tax they owe, and in most cases, make estimated tax payments throughout the year. Federal income tax operates on a graduated scale to determine how much you’ll pay. Rates run from a low of 10% to a high of 37%. The more you make, the more you pay.
Self-employment (SECA) tax is paid by independent contractors to cover the cost of Social Security and Medicare taxes, half of which are usually paid by a traditional employer. Because your independent contractor business doesn’t have an outside employer, responsibility for both portions of the SECA tax falls on your business. SECA tax is divided into two parts:
- Social Security = 12.4%. This part of the tax applies to the first $137,700 of earnings. If you earn more than that (from self-employment or, if you also have a job, from the combination of your job and your business), then the 12.4% part of the tax that pays for Social Security stops for the year.
- Medicare = 2.9%. The Medicare portion of the SECA tax doesn’t stop. No matter how much you earn, you’ll pay the 2.9% Medicare tax. If you earn over $200,000, or $250,000 for married couples, you’ll have to pay an additional 0.9% towards Medicare, which will bring your total tax burden to 3.8% on any income above the earnings threshold.
State and Local Taxes
While not every state levies an income tax, most do, and even if you do business in a state with no income tax, you’ll still need to pay attention to county or city taxes. For example, the city of Newark imposes a flat 1% income tax in addition to New Jersey’s income tax. Or look at Indiana. Each of its 92 counties levies an extra income tax on top of the state income tax. These taxes range from from a low of 1.5% to a high of 2.85%, depending on where you live. Beyond income taxes, be on the lookout for local property taxes and sales taxes that you’ll be expected to pay.
Should I form an LLC?
Many independent contractors operate as sole proprietors because there’s no paperwork to file and no fees to pay. The drawback of course is that a sole proprietorship offers no legal separation between the business and the person, which means your personal finances could be on the hook should you get sued or go bankrupt.
Business owners who want to run a business without jeopardizing their personal assets often choose to form an LLC. LLCs offer business owners liability protection from lawsuits or bankruptcy. Will an LLC change how you are taxed? Not necessarily. Single member LLCs, for example, are taxed like sole proprietorships, which means that profits are passed along to the LLC owner, who is then responsible for reporting the income on their personal tax returns.
However, with an LLC, you will have the option of electing to be taxed as an S Corp, which can potentially reduce the tax burden for high earning independent contractors.
To learn more about the potential tax savings of an S Corp election, check out our page on S Corps.
What tax deductions can independent contractors claim?
As an independent contractor, the IRS allows you to deduct reasonable and necessary expenses related to running your business. Tax deductions reduce net income, which can help to lower your tax bill. This is where record keeping comes in handy, because when tax time comes, you won’t spend hours sifting through a pile of receipts wondering whether that $30 restaurant bill was a work lunch or dinner out with your sister.
- Home OfficeDo you use part of your home for business activities? The IRS may allow you to deduct expenses associated with your home, including mortgage interest, insurance, utilities, repairs, and depreciation.
- Self-Employment TaxBecause you’ll be paying both the employer and employee portions of Social Security and Medicare taxes (15.3% of net earnings). The IRS allows you to deduct half of your self-employment tax. It won’t reduce the amount of SECA tax you owe, but it will help to reduce your income tax liability.
- AdvertisingBusiness cards, fliers, banners, Facebook or Instagram ads: all of these are deductible for your business.
- Health InsuranceIf you are not eligible to participate in a plan through your spouse’s employer, you can deduct all of your health, dental, and qualified long-term care insurance payments.
Use your car to get from job to job, or take clients out? Catching a flight to a job in another city? The IRS will allow you to deduct some of your travel expenses.
We’re Business Professionals
Whether you are an independent contractor or a massive corporation, taxes are an inevitable part of doing business. Northwest can’t do your taxes for you, but we can help you navigate business formation, or walk you through any number of business decisions with our helpful guides.
Interested in the benefits of an LLC for your independent contractor business?