As an independent contractor, you have the freedom to work on your own schedule and set your own prices for the services you offer. However, paying income tax is different for independent contractors compared to employees who receive W-2 forms from their employers.
Even though you can earn money based on your own rates, you are still required to declare the amount you earn on a deadline, whether paid quarterly or annually. You must file your taxes and ensure that you declare what you earn within that period on the due date.
This guide will help you understand how to pay taxes and report your income as an independent contractor. We will discuss the tax forms you need to use to ensure that you can complete the process without any issues.
Whether you’re using an accounting software or a professional, it’s important that you learn how to navigate the potential pitfalls that come with paying taxes as an independent contractor. Be sure to pay careful attention throughout the guide.
Independent contractors are subject to different types of income taxes. They include but are not limited to the following:
Before moving forward, it’s important we address the issue of who can qualify as an independent contractor. When it comes to filing and paying, income tax for independent contractors is entirely different from employees.
Employees and independent contractors differ when it comes to not just paying taxes, but also their status with the company. Unlike employees, independent contractors are not under the authority of the company they work with (i.e. - their client).
Independent contractors will have these attributes:
Because independent contractors follow a reporting method their income and fulfilling their tax obligations, it is important that they should consider the following actions:
1. Recordkeeping and documentation
When paying income tax for independent contractors, it is highly recommended that you maintain records of income and expenses that are related to their work. This includes keeping invoices for services that are clear and accurate. Invoices must include a date, the services performed, and the terms of payment.
Also, receipts should be kept for all business-related expenses. These can be deducted from taxable income. It will make it easier for you to manage these expenses not just for tax purposes, but also when you want to record them for your overall financial figures.
Numbers change over time depending on how much you earn. The amount you receive one year annually will differ the next. Thus, it is important to make sure you document everything regarding your self-employment income.
Because you may owe less taxes the next year or more. Again, it depends on how much you earn - quarterly or annually. When it comes time to declare how much you’ve earned - you need to look through your records (whether you entered them digitally or physically).
Remember, the amount you earn may determine which of the tax brackets you might be in. So pay attention to how much you earn each quarter or year. A specific amount may make a difference between which bracket you end up in.
As such, each tax liability will differ from independent contractors that earn less or more than others. Regardless, make sure you create record-keeping requirements to ensure your reports are as accurate as possible and to prevent errors.
2. Form 1099-NEC
A client that pays an independent contractor $600 or more for services throughout a tax year must issue a Form 1099-NEC. The NEC stands for (Non-Employee Compensation).
This form will outline the amount of total compensation that is paid to independent contractors. It will be used to report the income on their tax returns. Like employers that need to send out W2’s by the deadline (January 31), clients must send out Form 1099-NECs to any independent contractors by the same deadline.
Make sure you have this when you prepare to submit your tax forms. What you earn from each client is documented in these forms so make sure you look over each part of them.
3. Schedule C
This form will be used to report any income and deductible business expenses when filing their annual tax return on the regular Form 1040. You can calculate your net profit or loss from the activities of your business.
You can use the exact total or estimate how much you have earned or spent. This will be useful for freelancers and independent contractors every year.
Since independent contractors deal with different forms compared to employees, let’s help you get to know what they are and what their purposes are. While we’ve already explained Schedule C forms, we’re going to dig a little deeper discussing Form 1099-NEC and related forms that may go along with it.
Let’s take a look at the following tax forms that you will need as an independent contractor:
1. Filing Form 1099-NEC
As mentioned earlier, clients of independent contractors will need to issue Form 1099-NEC by January 31st. This will ensure that they receive this to verify the accuracy of the information provided before they move forward with filing their taxes.
2. Form 8829: Expenses for Business Use of Your Home (if applicable)
Another form that you’ll want to pay attention to is Form 8829. Your tax bill can be offset by expenses that you can account for in terms of business use for your home. For example, let’s take a look at your home office.
Did you know that the square footage of your home office can play a role in lessening your tax bill? You can also cite utility costs and home repairs as tax deductions as well. Finding out if you qualify for such deductions will require you to assess what you have spent and used for tools and equipment.
For a complete list of expenses that you can include in your Form 8829 (or if you’re stuck on what should be included), refer to the instructions provided by the IRS.
3. Form 4562: Depreciation and Amortization
This forum will be applicable to independent contractors if you have an asset that is depreciable and can be deducted on your tax return. These assets are known as tangible assets.
Depreciation is defined as writing off such assets over multiple tax years. To define a tangible asset, it’s something that you can touch or use to your advantage. For independent contractors, this can include furniture that you use for your home office.
Keep in mind that some intangible properties like computer software that you use for business purposes can also depreciate. Which means it can qualify under this form. Be sure to do an assessment of any assets - tangible or intangible - to see if they are a fit for Form 4562.
If you are unsure, you can always seek help from a tax professional. They can provide you with an idea of what to include as assets when it comes time to file taxes for the previous year.
Deadlines and reporting the withholding amount can be a challenge to navigate without the vital information you need to know about. There are two deadlines that you can take advantage of as an independent contractor - regarding both your annual return and your quarterly:
There are two major options when paying income tax for independent contractors. They include using tax preparation software or getting help from a tax professional. Before choosing which route to take, it is important to take a few things into consideration.
First, consider what will be the best option for your budget. Tax services - whether by software or a professional - don’t come cheap. Especially if you are filing as an independent contractor.
That’s why it is important to determine which route to take based on the amount you’re willing to spend on such services. But the amount you spend should not just be the only reason. If you’re someone who isn’t computer-savvy, then it’s clear that the tax professional option is your best choice.
If you are willing to get the job done on a computer, then you can choose the software option. You want to find one that is user-friendly and provide you with information that pertains to your state in terms of taxes. You will need to choose tax software that is specialized for self-employed individuals.
1. Benefits of Tax Software
Independent contractors can rely on tax software to streamline the preparation process. Users can experience such benefits including the following:
2. Popular Tax Software Options
Among the variety of tax software options on the market, TurboTax is among the most popular. You can also consider other options including H&R Block, Tax Slayer, and TaxAct among others. Check out which of the best options on the market will fit you best based on your needs, preferences, and budget.
1. When to Consider Professional Help
Tax software can be valuable most of the time. However, there can be situations where seeking tax advice from a professional is the best option. Let’s take a look at the following common examples:
2. Choosing a Tax Professional
When it comes to choosing a tax professional, it may be a good idea to choose someone who is local. This way, you’ll be able to meet someone face-to-face and can be able to walk you through an issue step by step.
This can be someone who is employed under firms such as H&R Block, Jackson Hewitt, or under their own name. It’s important to consider a tax professional that is experienced, fits your budget for consultation fees, and whether or not they are well versed in all things related to tax situations for independent contractors or self-employed individuals.
Alternatively, you may seek the help of tax professionals online. You may be able to consult with them via video call or Zoom. They may also be available to review your tax situation by way of email or live chat.
This option will be your best one if you don’t have a local tax expert in your area (and they happen to be a long drive away). Otherwise, you may want to consider visiting your local tax professional or possibly a Certified Public Accountant (CPA) who is well-versed in taxes for independent contractors.
As an independent contractor, you have a different tax status compared to regular employees. You do not have to withhold your taxes each time you get paid. On top of that, you deal with different tax forms such as the Schedule C, 1099-NEC, and others. So please make sure you find the appropriate tax forms whenever you’re filing taxes.
The good news is that you can find the forms online. Likewise, the forms are available on your favorite tax software. Please note that each form has its intent and purpose when you are filing taxes.
Independent contractors will need to pay quarterly estimated payments by the respective deadlines. It is also important that they keep track of any expenses that pertain to their independent contractor business. Keep any documentation and use them when it comes time to file.
You’ll never know what deductions you’ll qualify for. As always, if you have any questions or concerns, a tax professional can address them accordingly. For additional information, we encourage you to check out the frequently asked questions section down below so you are better informed about paying income tax for independent contractors.
Independent contractors are subject to paying the self-employment tax, which is currently at a rate of 15.3 percent. The rate is calculated based on the following: 12.4 percent of this tax will go to Social Security while the remaining 2.9 percent will go towards Medicare. Compare it to employees where each tax is withheld from their gross pay.
No. An independent contractor cannot be paid a salary. A salary is paid to workers who are considered employees. An independent contractor's pay is determined by the rates they charge for services. An independent contractor's rate varies according to the type of services they may provide for their clients. Yes, independent contractors can be paid on retainer by the client, mostly on a monthly basis or an agreed timeframe.
Your taxes will be calculated by income that is recorded on 1099 forms. These can include such versions such as the 1099-NEC, 1099-MISC, and 1099-K. Keep in mind that the income will be subject to the 15.3 percent self-employment tax rate.
Are you having trouble navigating 1099 forms? Check out this breakdown of all 21 1099 types, and you’ll understand their intended purpose and use in no time.
How do you send W-2 forms as an employer? How do you protect sensitive information when delivering W-2s? Find out right here.
It’s tough to figure out how much money to set aside as a 1099 contractor, especially with quarterly payments in play. Use this article to figure out how much you have to pay.
