If you’re self-employed or a freelancer, you likely get paid as an independent contractor rather than an employee. The IRS defines an independent contractor as someone who performs work for someone else, while controlling the way in which the work is done. In other words, someone pays you to perform a service or deliver a product, but they only have a say in the final outcome.
As an independent contractor, there are some unique responsibilities where taxes are concerned. Understanding the guidelines for filing and paying taxes as an independent contractor can help you avoid issues with the IRS.
Who Qualifies as an Independent Contractor?
The key characteristic of an independent contractor is retaining control of how the work they’re being paid to do is performed. With that guideline in mind, there are a variety of careers that offer the ability to work as an independent contractor, such as:
- Freelance writers
- Lawn care providers
Independent contractor status can apply regardless of how your business is structured. You could be considered an independent contractor if you operate as a sole proprietor, form a limited liability company, or LLC, or adopt a corporate structure. As long as you’re not classified as an employee, you can be considered an independent contractor.
Take note: If you hire people to work for you in your business, you’ll have to decide whether to classify those people as independent contractors or employees. Incorrectly classifying an employee as an independent contractor could trigger a tax penalty. The IRS considers someone to be an employee if the person who’s paying them to work can control what will be done by that employee and how it will be done.
How Is Independent Contractor Income Paid And Reported?
Employees typically get paid on a consistent schedule, such as weekly, biweekly or monthly. As an independent contractor, it’s up to you and the payer to come to an agreement on when you’ll be paid and how that transaction will take place. For example, the payer may mail you a check, pay you via wire transfer or send payment through an ACH deposit.
These payments are not considered a salary or wages for tax purposes because the payer doesn’t deduct any money for taxes from the payment. That means no federal income taxes, Social Security taxes or Medicare taxes are taken out before you receive the money. Be mindful of how you decide to receive the payment though – some services like PayPal may charge a fee.
Come income tax season, the payer is required to send you a Form 1099-MISC reporting all of the income they paid you the previous calendar year. This Form 1099-MISC takes the place of a W-2, which traditionally employed individuals receive from their companies. There is one exception to this rule though. If you earned less than $600, you’re still required to report the income, but the payer doesn’t have to send you a Form 1099-MISC. If you work with multiple people or businesses throughout the year, you may receive multiple copies of this form. Payers are required to have these completed and postmarked by the end of January each year.
Paying Taxes as an Independent Contractor
For tax purposes, the IRS treats independent contractors as self-employed individuals. That means you’re subject to a different set of tax payment and filing rules than employees.
You’ll need to file an annual tax return to pay federal income tax if your net earnings from self-employment are $400 or more. Along with your Form 1040, you’ll file a Schedule C to calculate your net income or loss for your business. You can file a Schedule C-EZ form if you have less than $5,000 in business expenses.
You’ll also be required to pay self-employment tax, which covers the amounts you owe for Social Security and Medicare taxes for the year. As of 2019, the self-employment tax rate is 15.3%. Self-employment tax is calculated using Schedule SE on Form 1040.
An additional 0.9% Medicare surtax applies to high-income earners. For 2019, the Medicare surtax applies to single filers and heads of household whose income exceeds $200,000, married couples filing jointly whose income exceeds $250,000 and married couples filing separately with income of $125,000 or more.
If you’re self-employed as an independent contractor and you expect to owe $1,000 or more in taxes when you file your annual return, you’re required to make estimated quarterly tax payments. These payments are designed to cover your self-employment tax and your income tax liability for the year. The first quarterly tax payment for each tax year is due in April. Subsequent payments are due in June and September, and then January of the following year.
Failing to pay your estimated quarterly taxes or underpaying them may result in a tax penalty. If a penalty is owed, it will be calculated when you file your annual return in April.
And remember, you’ll have to pay income tax and estimated quarterly taxes at the state level, too. Failing to pay state income taxes or quarterly taxes, or underpaying each quarter, can also result in a tax penalty.
Tax Deductions for Independent Contractors
Deductions lower your taxable income for the year and there are several deductions that you may be able to claim as an independent contractor. Depending on the kind of business you own, your deductible expenses might include:
- Advertising costs
- Business insurance
- Vehicle-related expenses
- Legal expenses
- Home office expenses
- Rent or lease payments
- Equipment purchases
Independent contractors can also claim a deduction for health insurance premiums they pay out of pocket. That includes premiums paid for medical, dental and long-term care insurance. If you’re married and/or have children, and pay for their insurance too, you may be able to deduct premiums paid on their behalf, as well. The exception to the rule is that you can’t deduct premiums for health insurance if you’re eligible to be covered by a spouse’s insurance plan.
As an independent contractor, you can also deduct personal expenses, such as mortgage interest paid, interest paid to student loans and real estate taxes. You can also get a tax break for contributing to a self-employed retirement plan or a traditional IRA. If you’re looking for a retirement plan option, consider a SIMPLE IRA, SEP IRA or a solo 401(k). These plans allow for deductible contributions, with qualified withdrawals taxed at your ordinary income tax rate in retirement.
Filing Your Taxes: DIY or Hire a Pro?
If you’re debating between filing your own taxes as an independent contractor or hiring a tax professional, consider your business income and expenses. If you have a fairly straightforward tax situation and don’t claim many personal or business deductions, then it may be easier and less expensive to use a tax filing software to do them yourself. On the other hand, if you have multiple business expenses to deduct, are a high-income earner or subcontract work to other independent contractors in your business, it may be worth the investment to hire a tax pro to avoid any mistakes or errors in your filing.
The Bottom Line
The tax rules for independent contractors and self-employed individuals are designed to ensure that you’re paying an appropriate amount in taxes, based on what you earn. While they’re different from what a traditional employee experiences, they’re not overly complicated. Getting familiar with the basics can make filing your taxes as an independent contractor easier to navigate.
Tax Tips for Independent Contractors
- Develop a good record-keeping system for your business. Make sure you have accurate records of both your income and expenses for the year. Consider using an expense app to keep tabs on receipts, charitable donations and other deductible expenses. And if you receive a Form 1099 for the year, match it against your own income records to check for accuracy.
- Consider working with a financial advisor to better manage your independent contractor income. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
Photo credit: ©iStock.com/mapodile, ©iStock.com/SchulteProductions, ©iStock.com/Deagreez