Working as an independent contractor can be quite liberating - you set your own working hours, choose your clients, and run your business as you see fit. However, it is very different than being an employee, especially when it comes to paying taxes. Whether you are a small business owner, a podcast host, or a designer offering services to clients, you will need to report and pay taxes as self-employed.
This article will cover all tax obligations and information for contractors and give you the insight you need to pay your taxes smoothly.
Disclaimer: This article is informational and so should not be considered tax advice.
Who is an independent contractor
In short terms, independent contractors work for other people or companies as non-employees. This means the clients hire you to do work for them, but they can only control the outcome of it. The IRS classifies independence in doing work as the most important qualification of contractors. Contractors are in charge of their working hours, equipment, where they work, and how they do their job. We recently wrote a full guide on independent contractors - check it out for an in-depth overview.
Independent contractors can be sole proprietors, but they can also own an LLC. The legal form of your business does not indicate your tax designation. Contractors are essentially self-employed, regardless of how they choose to structure their business.
Automate your tax document collection
From collecting tax forms to storing them all in one place, we automate everything, so you can stay focused on growing your business.Learn more
Independent contractor taxes: an overview
Understanding your tax liability as a contractor can be daunting, especially if you've only worked as an employee before. Being self-employed requires you to get familiar with different taxes since paying them is entirely your responsibility. As an independent contractor, you will need to pay both the self-employment tax and income tax.
Simply put, the self-employment tax is the contractors' version of the FICA tax paid by employers. Self-employment tax (SE tax) covers your Social security and Medicare contributions. The rate of the SE tax was 15,3% in 2019, and you are expected to pay the full amount. However, you can get a deduction for half of your SE tax when you file the tax return. There is also an additional surtax for Medicare amounting to 0,9% for high earners.
The second tax on your list is the federal income tax. In the United States, the tax system is progressive, which means you pay more when you earn more. There are seven tax brackets in 2020, and you can calculate which one you are in by subtracting deductions from your business income. The federal income tax rates range from 10% to 37%.
Federal vs. state and municipal taxes
The two types of taxes we covered above are federal taxes. Depending on the state you live in, additional state or municipality taxes may apply. Several states don't charge personal income tax, such as Texas, Florida, Washington, Nevada, and others. State and local regulations vary considerably, so we advise you to check out the tax authority in your state for detailed information.
Quarterly tax payments for the self-employed
Independent contractors pay Social Security taxes, Medicare taxes, and income tax by themselves because there are no employers who withhold these taxes from a salary. For this reason, the IRS uses a method called an estimated tax. Estimated tax means calculating how much you will owe for the year and making quarterly tax payments to the IRS.
You need to pay estimated quarterly taxes if, as a contractor, you expect to owe more than $1,000 in taxes per tax year. The due dates for submitting quarterly SE tax and income tax returns are April 15th, July 15th, September 15th, and January 15th.
Tax deductions for independent contractors
If by now we have you worried about the amount you will have to pay in taxes, do not fear. There are plenty of tax deductions that independent contractors can claim as business expenses. Deductions can considerably lower the amount of taxable income, so don't forget to claim them in your tax return. We covered tax deductions in-depth in a previous article, but here are some that may apply to your business:
Some contractors, especially those working as freelancers, often work from home. Since, in this case, part of your home serves as a place of business, you can write off a portion of your rent, mortgage, or property taxes. There are two requirements you need to meet to qualify for this deduction. First of all, the home office must be a dedicated place you use exclusively for work. Second, the home office must be the primary place for doing business. The home office deduction is calculated by determining the percentage of your total home area that the home office occupies.
There is a special deduction for home offices under 300 square feet. For these, the IRS uses a simplified calculation - instead of detailing the expenses, you are allowed to claim $5 per square foot, with a maximum allowance of $1,500 per year.
If you pay a health insurance premium out of pocket as a contractor, that payment is tax-deductible. This deduction includes health care and dental insurance for your spouse, defendants, and children under 27 as well. Even your long-term care insurance premiums can be covered in this deductible.
While buying a car is not part of the deduction, mileage, tolls, parking, and other vehicle-related expenses are all tax-deductible. The IRS's mileage deductible rate is $0.57 per mile, and you are required to keep the receipts and add them in your 1099 filing.
Advertising and promotion
It may come as a surprise, but the activities you undertake as a contractor to promote and advertise your business are 100% deductible. This applies to media ads (print and online), printing promotional materials such as business cards or leaflets, hiring a designer to make your new website, or posting ads on social media.
As a contractor, you should always have separate bank accounts and credit cards for your business. All bank fees, credit card company charges, overdraft fees, and similar expenditures are deductible. You can also deduct transaction fees paid to third-parties such as PayPal.
Depreciation is a term that often comes up when we talk about tax deductions, but it can sometimes confuse business owners. Depreciation means that when you buy the equipment you use for business, you can't deduct its price all at once. Instead, you spread the cost of your business equipment over the years of use. There are several ways for taxpayers to write off the full equipment costs in one year, but they are more complicated than regular deductions and may require you to consult a tax professional.
Cell phone and internet expenses
If your business operates in such a way that the internet and a cell phone are crucial for your operation, you can deduct these costs as well. However, make sure to have a separate phone number for the business. In this case, you can deduct the entire cost of the phone plan.
If you are self-employed, chances are you know how important education and professional training are in the modern-day economy. Investing in your skills and credentials is always a good business move, and luckily, the costs of education can be written off your tax bill. You can deduct anything from webinars, books, professional publication subscriptions, etc.
Business travel expenses are tax-deductible as long as the trip is made for business purposes only and outside your tax home, meaning your area of conducting business. Make sure to keep the receipts for transportation, meals and lodging, dry cleaning, and similar expenses, as you will need to submit them with your tax return.
Tax forms for clients hiring contractors
Now that we have covered the basic functioning of which taxes you pay and what you can deduct, it's time we dive into the specific tax forms your clients will need to fill out.
Let's start with Form W-9. This is a prerequisite for all other forms you will need. The W-9 or Request for Taxpayer Identification Number and Certification is used by companies or clients working with independent contractors based in the United States. If a client pays you more than $600 per year, they need to obtain this form. The W-9 contains the name, address, and Social Security number or tax identification of the contractor. Neither you as the contractor nor the client submit the W-9 to the IRS.
If you are a contractor located outside the US and your client is a US-based company, you will need to provide your client with a filled out W-8 BEN or W-8 BEN-E. These forms, also known as Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting, prove that the contracted person or entity is not a US citizen and performs work outside of the United States. The W-8 forms don't expire and, once filled out, are valid until any facts in it change. There are two W-8 forms - one for individuals and the other for entities. For an in-depth guide on how to fill out the W-8 forms, check out this article.
Next up is Form 1099-NEC. As a contractor, you need to receive Form 1099-NEC from every client who paid more than $600 to you during a year. The IRS requests the clients to send the 1099-NEC to every independent contractor until January 31st. The form needs to indicate the amount paid to each contractor during the previous year.
Important note: Starting from the tax year 2020, companies should use Form 1099-NEC instead of the Form 1099-MISC. The IRS introduced this new form, 1099-NEC (Non-Employee Compensation), specifically for reporting payments to independent contractors. Make sure to start using it in 2021!
How to file taxes as an independent contractor
Now is the time to get you prepared for the tax season and the filing of your tax returns.
You can file your taxes either by mail or online. We recommend you opt for the online method, for several reasons. First, it's quicker, and you don't need to order the forms online, nor do you need to use checks for payments. For filing the taxes online, you need to open an account on the IRS website, and you can transfer the money directly from your bank account or credit card. On the other hand, filing online also saves all your information, including payment history, on the account, so you don't need to worry about papers getting lost.
The first step in the process of filing taxes is determining whether your business made a profit since you only need to file a tax return with the IRS if your net earnings from the business are over $400. You can calculate the net income or loss of your business by using the Schedule C of Form 1040, also known as Profit or Loss from Business (Sole proprietorship). In some cases, you can use the simplified Schedule C-EZ of Form 1040 - for example, if your business expenses are less than $5,000.
When it comes to the self-employment tax, which covers Social Security and Medicare taxes, you will need to use Schedule SE on Form 1040 to calculate how much you owe based on the self-employment income. If you expect to owe more than $1,000 when you file your annual return, you will need to make the quarterly tax payments we already mentioned.
These estimated tax quarterly payments cover your SE tax and income tax liability. For estimated tax purposes, you use the worksheet in Form 1040-ES. In this form, you enter your expected gross income, taxable income, and deductions.
Make sure to pay your quarterly taxes in time and not undervalue them, since both of these actions can result in a tax penalty or an IRS audit. If you happen to overpay the quarterly taxes, you will get a tax refund from the IRS.
Deadlines for independent contractor taxes
There are four quarterly tax payments for the estimated tax every year. The deadlines for them are:
- April 15th
- June 15th
- September 15th
- January 15th
Your deadline for paying the personal income tax is April 15th each year. Finally, Form 1040 (with Schedule C) is filed at the end of the year, with your final quarterly estimated tax payment.
Tax tips for independent contractors
Now that you are fully familiar with the whole topic of contractor taxes, there are some tips and tricks to keep in mind to make tax time less burdensome for your business and you personally.
Hiring a tax professional
If, after all of the forms and deadlines we went over, you don't find yourself wanting to do taxes by yourself, consider hiring an expert. There are plenty of accountants specializing in small business taxes, and some of them have a CPA (Certified Public Accountant) certification. Make sure to look for an accountant specialized in your branch of business - their expertise may help you save thousands of dollars in deductions and countless hours browsing the IRS tax center. Don't forget that tax professionals' fees are tax-deductible.
One of the crucial tricks in making tax season less stressful is having your books in order. Tax preparation takes way less when your documents and records are under control. Whether your business as a contractor is part-time or full-time, we recommend implementing one of the many available small business bookkeeping solutions. These will enable record-keeping for different business expense categories and make closing the financial year way easier.
Also, we mentioned receipts for tax deductions earlier. Luckily, in the digital age, you don't need to keep paper trails that may get lost, and the ink may fade away. Instead, the IRS can use your credit card reports, and you can store your receipts digitally - make sure to snap photos or scan the receipts and store them in a dedicated folder for when you need them.
If you are a contractor working with multiple clients, consider using Deel. Deel offers a streamlined process for both you and your clients, with an automated collection of tax documents (such as W-8, W-9, and 1099), smart invoicing, local labor law compliant contracts, and worldwide payments.
Schedule a product tour with a specialist to learn more.
Phew...you did it!
We hope this article was useful in helping you navigate the exhausting world of tax compliance. Although taxes can be difficult in the beginning, they get easier when you are equipped with information. And when tax season is over, you can shift your focus back to work and making the most of your freelancer life.