An independent contractor is someone who works for a business or company but is not an employee. The IRS uses three categories of evidence to determine if someone is an independent contractor or employee: behavioral control, financial control and the relationship of the parties.
Learn the details of what it means to be this kind of worker, and everything you need to know about how to file taxes if you’re an independent contractor.
As an employee, the employer is required to withhold income tax, Social Security tax and Medicare tax from your pay. As an employee, the employer pays half of the total Social Security taxes and Medicare taxes on behalf of the employee. At the end of the year, the employer is required to provide a Form W-2 to the employee detailing all wages, and the amount of taxes withheld.
As an independent contractor, the employer does not withhold any taxes. The contractor is responsible for paying all taxes, including the other half of Social Security taxes and Medicare taxes typically paid for by an employer. These taxes are often referred to as self-employment taxes.
Key Tax Forms for Independent Contractors
Like most employees, the taxes for an independent contractor are typically due on April 15 of each year. The independent contractor files a Form 1040, just like an employee. However, there is a significant difference in how income is reported for contractors.
Income earned as an independent contractor is typically reported with the contractor’s Form 1040 on a Schedule C. The total amount of all income reported on Form 1099-NEC, which has replaced Form 1099-MISC for independent contractors, is included on Line 1 of the Income part of the Schedule C. As a business, the contractor can deduct certain expenses on this form as well.
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Unlike an employee, the independent contractor must pay self-employment tax on income minus deductions. The self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare taxes as a percentage of net earnings, for a total self-employment tax of 15.3%. This rate applies to the first $137,700 of earnings. After that amount, only Medicare taxes are collected at a rate of 2.9%.
This tax is calculated on Schedule SE, Self-Employment Tax. This calculated tax is reported on the independent contractor’s Form 1040 on Line 57, Self-Employment tax under Other Taxes.
Quarterly Tax Payments
To comply with IRS rules, the contractor might need to make quarterly tax payments on their income. Estimated tax payments are due four times per year on the 15th of the month following each quarter. For example, the estimated tax payment for the first quarter — Jan. 1 through March 31 — is due on April 15.
Estimated tax payments are required from independent contractors who expect to owe taxes of $1,000 or more when their tax return is filed. Unlike an employee, whose employer calculates tax withholdings, the independent contractor must estimate their own quarterly tax payments. Also, whereas an employee’s taxes are withheld from pay by the employer, an independent contractor must make their own payments directly to the IRS. The IRS recommends contractors use previous year’s income and deductions as a starting point for these calculations. The IRS provides an options Form 1040-ES worksheet to assist in the calculations.
Tax Deductions for Independent Contractors
As independent contractors are technically business owners, they’re allowed to take numerous tax deductions that don’t apply to most wage and salary earners. The most common of these include the following:
Home office expenses. You can deduct qualifying home expenses, such as a percentage of your mortgage interest, utilities, and homeowners insurance if you work from a dedicated space in your home.
Business supplies and equipment. Common office expenses like printer paper, ink, pens and postage are deductible. Professional instruments and equipment that will be used within one year are fully deductible, while those expected to last longer can still generate a depreciation deduction.
Internet and phone costs. If you have a phone and/or internet that’s used for business expenses, those costs are deductible.
Mileage and travel expenses. Traveling to and from business meetings can result in deductible mileage and travel expenses.
Health insurance premiums. If you’re self-employed and pay your own health insurance premiums, those can be deductible.
Filing Taxes as an Independent Contractor
The process of filing taxes as an independent contractor is the same as if you were an individual filer. But you’ll generally have more deductions to organize, and oftentimes more sources of income to keep track of. Here’s a step-by-step guide to filing:
Organize all your tax forms. This is the part that can be complicated for independent contractors, as they typically have multiple sources of income. Make sure to include all 1099-NEC forms that you receive, along with any other that show any type of income paid to you directly.
List all of your expenses. One of the big benefits of being an independent contractor from a tax perspective is that you can deduct many things that W-2 employees can’t. This is the single step that can likely save you the most on your taxes, so it’s important to find every deduction that you’re entitled to.
Choose the right software, or use a tax professional. Filing taxes as an independent contractor can be a land mine. To get the best results, it’s usually a good idea to hire a professional or at least use good tax software.
Provide all your information to your professional, or enter it into your software. From there, the process should be fairly straightforward.
File your taxes online. The safest, fastest, easiest and best way to file your taxes is electronically.
Avoiding Common Tax Mistakes
Tax reporting can be a more difficult process for independent contractors because there are so many opportunities to make errors. Whereas a W-2 employee simply has to report the income on that tax form and often little else, an independent contractor has to deal with multiple streams of income, quarterly deadlines and self-reported expenses and deductions. Here’s a list of some of the most common mistakes you’ll want to try to avoid:
Underreporting income. This is one of the things that’s easiest to do as an independent contractor but it’s one of the main red flags that could lead you to an IRS audit. If you receive multiple 1099-NEC forms, it can be hard to keep track of them all sometimes, particularly if a few were one-off projects or jobs that paid small amounts.
Failing to meet tax-filing deadlines. A regular W-2 employee has taxes deducted from each paycheck, making the tax-filing process easier. Independent contractors must usually file quarterly estimated taxes, as none of their income is withheld.
Failing to keep receipts. Although independent contractors are entitled to a wide range of deductions, if you can’t substantiate them by keeping diligent records and receipts, they may be disallowed by the IRS.
Mixing business and personal expenses. This is another IRS red flag that can often lead to an audit. It’s usually a good idea to keep separate checking accounts for your business and personal finances – and separate credit cards as well – so you can more easily document your claimed business expenses.
The Bottom Line
Filing taxes as an independent contractor is a year-round job. Keep diligent records of both income and expenses – and be mindful of tax-filing deadlines – and you can make the process much easier to handle. You’ll also avoid penalties and get all of the tax deductions to which you’re entitled.
John Csiszar contributed to the reporting of this article.
