How to Report and Pay Independent Contractor Taxes
Answers to Your Questions about Taxes as an Independent Contractor
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. 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 is simply someone who works for someone else, but not as an employee. For income tax purposes, you are considered a sole proprietor. The designation of “sole proprietor” is simply the default form of small business. You don’t need to pay to register your business with your state or with the IRS, and you don't need to incorporate (form a corporation).
How does being an independent contract affect my pay?
You still get paid for the work you do in your business, but your payments are not a salary or wages. These payments are business income. You don't get a salary from your business. 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 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. Of course, you can't get out of paying taxes, and you must still pay federal and state income tax on your income from your work as an independent contractor, through the business tax return. Taxes for social security and Medicare also must be paid; this combined tax is called self-employment tax for independent contractors.
How does being a sole proprietor/independent contractor work for taxes?
When you prepare your personal income taxes, you will also prepare a form called a Schedule C, which lists your business income from all your contracting work, minus any expenses. Many IC’s can file what’s called a Schedule C-EZ, in which you merely list your total income and summarize your expenses. It takes only minutes to complete.
What expenses can I deduct as an independent contractor?
You can deduct typical business expenses that you have paid. For any expenses, you must have excellent records, made at the time of the expense, to show that it was a business expense and the amount of the expense, in case of an audit. Here's a list of business tax deductions from A to Z.
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.
How do I know what expenses are for business?
The IRS says that only expenses that have a specific business purpose can be deducted. If you want to deduct expenses, these expenses must be clearly for your business, not personal. Also, the expenses must be clearly documented, with the date, amount, and business purpose.
If your business has a profit, you might need to make estimated payments for your business taxes. But, if you have other sources of income, you may be able to increase your the withholding on income from a job to account for the additional income tax and self-employment taxes you might have to pay. Just to be clear, the estimated taxes must cover both your federal income taxes and the self-employment tax you owe for Social Security and Medicare.
First, see if you can increase the amount withheld from your pay from other income sources. If you don’t have any withholding amounts to adjust, you may need help to figure out whether you will have to pay estimated taxes on your income as an independent contractor. 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 advisor.
The tax stuff sounds complicated. Will I have to pay someone else to do my taxes?
You may need help with (a) Schedule C or Schedule C-EZ, (b) Schedule SE to calculate the amount of self-employment taxes, and (c) the calculation of estimated taxes due. 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 receive a W-2 for income tax purposes?
Instead of receiving a W-2 in January of each year, you will receive a 1099-MISC form showing the total amount you earned from each client for whom you worked during that year. If your payments from any one 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 a sub 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 12 of your Form 1040. It gets added in with any other income, and then the tax is calculated on your total adjusted gross income.
What about 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 and included on my tax return?
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 which is added to the total income tax you must pay.
An example of taxes for an independent contractor:
An independent contractor, let’s call her Carol, works for several clients in 2018 and she earns in total $18,000 for the year, as shown on the 1099-MISC forms she received. She has no other income, but her husband Tom has a full-time job and they file a joint tax return.
She files a Schedule C-EZ for her 2018 business taxes. She can prove she drove 250 miles back and forth to work assignments, so (at the IRS mileage rate for 2018 of 54.5 cents a mile) she can deduct $86.25. This makes her net income from her business $18,000 less $86.25, or $17,913,75. This amount goes on their 1040 on Line 12: Business income (or loss).
She must also pay self-employment tax on $17,913,75. She can use a short form Schedule SE. The result of the Schedule SE calculation show she owes $2687.05 (15.3%)for self-employment tax. Carol gets credit for this amount of Social Security benefits. Half of this amount ($1343.53) is deducted on Page 1 of her income tax return, to reduce her total adjusted gross income for the year.
To account for the additional self-employment tax, Tom could increase his withholding from his work, or Carol could begin paying estimated taxes, taking the full amount of $2,687.05 and dividing it by 4 and paying one-fourth each quarter (April 15, July 15, October 15, and January 15, 2016).
This is just one example of how independent contractor taxes might work. Your situation might be totally different, so please check with a tax professional or use one of the tax preparation software programs to help you prepare your taxes.