How to Report and Pay Independent Contractor Taxes

Answers to Your Questions about Taxes as an Independent Contractor

Independent contracting and taxes illustration
The Balance

Being self-employed often means being an independent contractor—that is, an independent business person. It’s really just another way of getting paid for your work, not as an employee. If you have been an employee and you're now self-employed as an independent contractor, you'll find that taxes are different. 

In this article, you'll find out about how to pay yourself, how you must pay taxes on your business income, and how you can save money on your business taxes by deducting business expenses.

What Is an Independent Contractor?

An independent contractor (IC) is simply someone who works for someone else, but not as an employee. An employee is someone who works for a business and the business controls what will be done and how it will be done.

An independent contractor is considered to be self-employed because the independent contractor carries on a trade or business, and is in business for themself, including on a part-time basis.

The IRS says an independent contractor is someone who offers services to the general public. This person is hired to do specific work and is paid on the result of the work, not what will be done or how it will be done. You are not an independent contractor if someone else controls what will be done and how it will be done, in other words, the details of how the services are performed.

Are Independent Contractors Sole Proprietors?

For income tax purposes, if you are an independent contractor you are considered a sole proprietor. A sole proprietor is a single-owner business that is not a corporation.

The designation of “sole proprietor” is the default form of small business. You don’t need to pay to register your business with your state. All you need to do is register your business trade name with your locality

Independent Contractor, Sole Proprietor, and Self-Employed Person

The term independent contractor describes how the person works and how much control the worker has over their work. The independent contractor isn't controlled by an employer as an employee is.

Independent contractors are considered self-employed because they are in business for themselves.

The term sole proprietor is a tax designation. It's how a single business owner, including an independent contractor, that is not a corporation pays taxes.

How Does Being an Independent Contract Affect My Pay? 

You can still get paid for the work you do in your business, but your payments are taken from your business income, not a salary or wages. The money you receive for your work or your products goes into your business checking account (yes, you should have a separate business bank account). You can take money out of the business (it's called a "draw"), but not as a salary because you are an owner—not an employee.

The amount you take out of your business as an owner doesn't affect your taxes. You must pay tax on ALL the income of your business, whether you take it out or not. 

Because you aren't an employee, the payments you receive from your business don't have any federal income tax withholding taken from them, and there are no deductions for Social Security or Medicare (called self-employment taxes).

How Does an Independent Contractor Pay Income Tax?

Federal Income Taxes

When you prepare your personal income taxes, you must use a specific schedule within your personal tax return (on Form 1040 or 1040-SR). This form, called a Schedule C, lists all the sources of your business income and all your business expenses.

Your net income (profit) from Schedule C is included on your tax return, along with other income you receive, including self-employment taxes, to get your total taxable income.

State Income Taxes

Most states have income taxes, and yes, you must pay those state income taxes on your income as an independent contractor.

How Is Self-Employment Tax Calculated?

The net income amount (the “profit”) from your Schedule C is to determine the amount of self-employment tax you owe. This calculation is done on Schedule SE. The result of this calculation is a tax amount that is added to the total income tax you must pay.

What Expenses Can I Deduct as an Independent Contractor?

You can deduct the typical business expenses that you have paid. For any expenses, you must have excellent records made at the time of the expense to show the business expense and the amount, in case of an audit. Here's a list of business tax deductions from A to Z or see IRS Publication 535 for more information on business expenses.

You want to take as many legitimate deductions as you can. But you must be able to prove that the money was spent and that it was for business purposes. That's why good record keeping is so important.

How Do I Know What Expenses Are for Business?

The IRS says you can only deduct expenses that are both "ordinary and necessary" for your business. Ordinary expenses are those common expenses in your type of work (like drafting tools for a draftsperson). Necessary expenses are helpful and appropriate. If you want to deduct expenses, they must meet this "ordinary and necessary" test and not be personal expenses. Be sure to document the expenses with the date, amount, and business purpose.

Will I Have to Pay Quarterly Estimated Tax?

As a business owner, you don't have a paycheck, and you don't have withholding for federal income tax, state income tax, and self-employment taxes.

If your business has a profit, you might need to make quarterly estimated payments to pay your income taxes on your business income and other income and for self-employment taxes.

If you have income from the previous year, you can use that as a basis to calculate your estimated tax bill or work with a tax preparer.

If you have another source of income as an employee, you may be able to increase your withholding on income from a job to account for the additional business tax and self-employment taxes you might have to pay.

Will I Have to Pay Someone Else to Do My Taxes?

If you have a simple business tax return, with no employees or product inventory, you may be able to use one of these online business tax preparation services.

Will I Get a W-2 for Income Tax Purposes?

Instead of receiving a W-2 in January of each year, you will receive (beginning with the 2020 tax year) a form called a 1099-NEC from any client or customer that paid you $600 or more during the year. If your payments from any single client are less than $600, you won’t receive a 1099-MISC form, but you still must include the amount you were paid on your business tax return.

How Do I Pay Income Taxes on My Income as an Independent Contractor?

First, you must determine the net income from all of your business activities. The income from your work as an independent contractor is recorded on Schedule C. Income from your work as an IC is listed, then any deductions are taken, to get a net income number. This number is brought to Line 3 of Schedule 1, and to Schedule SE, line 2. The information on these schedules is included on Form 1040 to calculate your total adjusted gross income. 

Can I Get a Qualified Business Income Deduction?

The 2017 tax law included a new tax deduction for small business owners, called the Qualified Business Income (QBI) deduction. This deduction is 20% of qualified business income in addition to your usual business expense deductions. Independent contractors can take this deduction for tax years between 2018 and 2025. The deduction may be limited or not applicable for higher-income business owners. Check with your tax preparer for more information.

Taxes for an Independent Contractor – An Example

An independent contractor—we'll call her Carol—works for several clients in 2020, and she earns in total $27,000 for the year, as shown on the 1099-NEC form she received from her clients for her 2020 work. She has no other income, but her husband Tom has a full-time job and they file a joint tax return.

She completes a Schedule C for her 2020 business taxes, and her net income from her businesses is $18,000 after deducting allowable expenses. This amount goes on Schedule 1, Line 3, then to Form 1040.

She must also pay self-employment tax on $16,623 (93.5% of $18,000) of her business income. She can use a short form Schedule SE. The result of the Schedule SE calculation show she owes $2,543.32 (15.3%) for self-employment tax. Carol gets credit for this amount of Social Security benefits. Half of this amount ($1,271.66) is deducted.

To avoid tax penalties for late payment, Tom could increase his withholding from his work, or Carol could begin paying estimated taxes, taking the full amount and paying one-fourth each quarter (April 15, July 15, October 15, and January 15, 2021). 

This is just one example of how independent contractor taxes might work. Your situation might be different, so check with a tax professional or use one of the tax preparation software programs to help you prepare your taxes.

Article Sources

  1. IRS. "Employee (Common-Law Employee)." Accessed May 5, 2020.

  2. IRS. "Self-Employed Individuals Tax Center." Accessed May 5, 2020.

  3. IRS. "Independent Contractor Defined." Accessed May 5, 2020.

  4. IRS. "Sole Proprietorships." Accessed May 5, 2020.

  5. IRS. "Independent Contractor Defined." Accessed May 5, 2020.

  6. IRS. "Publication 334 Tax Guide for Small Business." Page 31. Accessed May 5, 2020.

  7. IRS. "Form 1040 U.S. Individual Income Tax Return." Accessed May 5, 2020.

  8. IRS. "Schedule C (Form 1040 or 1040-SR)." Accessed May 5, 2020.

  9. IRS. "Facts About the Qualified Business Income Deduction," Accessed May 5, 2020.