Being an independent contract can be a great career option for one as it allows some people to enjoy the flexibility in their full-time job. Although being an independent contractor may have many benefits, it can make ones taxes more complex. It is imperative that you understand the tax implications of being an independent contractor so that you are no caught off guard when tax times comes around.
In this guide, we’ll walk you through what you need to know when it comes to independent contractor taxes.
An independent contractor is defined by the IRS as an individual that provides services but is not considered and employee, therefore, considered self-employed. Generally speaking, the IRS states that one is considered an independent contractor if the payer of services can only direct the result of the work and not where or how the work is done. Here are a few examples of independent contractors:
Independent contractors can be sole proprietors, or have a registered business like an LLC or corporation.
Unlike a normal employee that is paid on a regular interval - weekly, bi-weekly, or monthly - an independent contractor's pay schedule is dependent on receiving payment for services rendered to their clients. This schedule is usually determined by the payment terms on the invoice to the client.
Since you are not paid through an employer's payroll, you will need to find an alternative method of payment. This alternative could be accepting credit card payments, or using a payment processing platform such as PayPal, Stripe or many others out there. It is worth noting that if one does use a payment platform, there are fees associated with every transaction.
Much like a normal employee that receives a W2, you will have to federal and state income taxes (if applicable). In addition, you will also be liable for the self-employment tax as well, which will cover social security and Medicare taxes. The self-employment tax is imposed to account for the Medicare and Social Security taxes that would have been withheld from your paycheck as an employee. Since employers usually pay half of the aforementioned taxes for their employees, you will end up paying slightly more in self-employment taxes then you would as an employee.
The current self-employment tax rate as of 2021 is 15.3%— 12.4% for social security and 2.9% for Medicare. If you were an employee instead of an independent contractor, you’d split that cost with your employer. You’d have 7.65% withheld from your paycheck to pay those taxes and your employer would have to pay another 7.65% in taxes.
Some common tax deductions you can take as an independent contractor include:
You can also take a deduction for 50% of your self-employment tax. For example, if you have to pay $1,500 in self-employment tax, you’ll be able to take a tax deduction of $750.
The United States is a pay as you go system, so as you earn money, you should be sending the government taxes. This remittance of taxes is much easier as an employee since your employer is responsible for collecting and filing the taxes, but as a self-employed individual, you will be responsible for filing your own taxes throughout the year. The IRS requires that you file taxes 4 times throughout the year, and these estimated payments should match your tax liability for the year.
Estimated tax payments are made four times per year on the following due dates:
If the due date falls on a weekend or holiday, the due date is moved to the next business day.
If you will owe tax of more than $1,000 for the year, the IRS requires that you make estimated tax payments. Payments are made to the federal government using IRS Form 1040 ES. Check with your state for specific information on how to make estimated tax payments.
In anticipation of filing your taxes as an independent contractor, you’ll want to gather the following documents, at a minimum:
You’ll also want to provide your clients with form W-9. This form provides them with the information they need in order to issue you a 1099-NEC. That includes your name, your address, your business structure, and your taxpayer identification number (TIN). You can use your social security number as a TIN or apply for EIN (employer identification number).
Because there are a lot of different things to keep track of, being organized is crucial. It’s a good idea to start using a bookkeeping system to track your income as well as deductions. Being organized won’t just make tax time easier, but it will help you maximize your tax deductions.
There is a lot to know when it comes to filing your taxes as an independent contractor. Having an expert in your corner who can help you make sense of the rules as well as identify any potential tax deductions can make all the difference. Millennial Financial Service can connect you with an expert who knows the ins and outs of independent contractor taxes and can file for you, making your tax season much easier.
