Starting your own business means autonomy, freedom, and flexibility as you set the pace for your career. However, independent work is not as simple as it may seem–especially when it comes to filing taxes. In the absence of an employer who largely handles taxes and withholdings on behalf of employees, independent contractors are fully responsible for taking care of their own business taxes all year round.
What is an Independent Contractor?
An independent contractor is someone who owns their own business, providing goods or services to clients for a fee. Independent contractors decide how much to work, who to work for, and what the work looks like. They are their own boss, as even clients don’t decide exactly how work gets done. Independent contractors may work in a variety of industries, having jobs such as:
- Virtual Assistants
- Hair Stylists
- Personal Trainers or Coaches
- Truck Drivers
If you make at least $400 a year through self-employed work, you are required to pay taxes as an independent contractor.
How the IRS Defines Independent Contractors
The IRS defines independent contractors as anyone who makes money from clients or customers rather than an employer. If you have an employer who pays you a salary and controls your work in terms of what you do and how you do it—rather than just the result of the work—you likely do not qualify as an independent contractor. In an employer-employee relationship such as this, your employer will be in charge of withholding a portion of your paycheck for FICA (social security and Medicare taxes) and income taxes.
Types of Independent Contractors
Independent contractors can set up their business in different ways, which will influence their liability, although the tax filing is relatively similar. The two most common types of independent contractors are sole proprietors and limited liability corporations (LLCs).
Sole proprietors refer to individuals who own an unincorporated business, meaning their business earnings and personal income are legally one and the same. Although this means that liability is squarely on the shoulders of the business owner, it makes owning a business less expensive and is ideal for freelancers or individuals with side gigs.
Limited Liability Corporation (LLC)
An LLC offers greater protection for business owners by legally separating them from their business (thus limiting their liability) while still allowing them to be taxed in almost the exact same way as a sole proprietor. LLCs are taxed as “pass-through” entities because the profits go straight to the owner (in the case of a single member LLC), who is then responsible for paying self-employment and income taxes on profits, just as a sole proprietor would.
An LLC may also be multi-member, meaning that it has more than one owner sharing the profits, though this structure is taxed somewhat differently.
What Taxes Do Independent Contractors Pay?
Just like a W-2 employee, independent contractors need to pay local, state, and federal income taxes. These will vary depending on where you live, and some states, like Washington, do not even have an income tax. Independent contractors are also responsible for fully paying their Social Security and Medicare, which normally would be split with an employer. These are covered by the self-employment tax, which is usually around 15.3%.
As an independent contractor, there are six essential IRS forms you should know about:
- Form 1040 – Anyone who has ever filed an annual tax return should recognize this form! This is where you outline your gross income and deductions to determine if you owe anything on your taxes or if you’ll receive a refund.
- Schedule C – If you are an independent contractor, you will need to file a Schedule C along with your Form 1040. This covers business-specific income and small business tax deductions (more on these later!)
- Schedule SE – Though not something you’ll necessarily need to file, the Schedule SE is a helpful form for the self-employed to calculate self-employment taxes. This tax is paid quarterly based on your net income from the previous year, so this form is helpful in making sure you don’t underpay.
- Form 1099-MISC – This is another form you won’t need to worry about filling out and submitting yourself. Any clients who paid you more than $600 are required to send you a 1099-MISC to report this payment.
- Form 1099-K – Similar to Form 1099-MISC, this form reports on any non-employment income above from a specific source, though in this case, it comes from third-party payment platforms such as PayPal and Venmo.
- Form W-9 – Your clients may ask you to send this form, as they require it in order to send you Form 1099-MISC at the end of the year. This gives your clients tax identification and certification that they will need to file taxes.
Tax Deductions for Independent Contractors
As an independent contractor, most business-related expenses can be deducted from your taxable income, reducing the amount of taxes you owe. Some of the most common business tax deductions include:
- Home office
- Business insurance
- Advertising and marketing
- Equipment and supplies
- Software subscriptions
- Vehicle expenses
- Start-up Costs
- Business-related meals
- Business-related travel expenses
- Phone and internet
Some of these deductions, such as a home office or your car, can only be partially written off to cover the portion used for your business. Others that are entirely exclusive to your business can be fully deducted from your taxable income.
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How to Pay Taxes as an Independent Contractor
1. Pay Quarterly Estimated Tax Payments
If you expect to owe more than $1,000 in annual taxes, you must pay estimated self-employment taxes each fiscal quarter or you risk owing a penalty payment. Unless it falls on a weekend or holiday, these taxes are due on April 15, June 15, September 15, and January 15.
To pay your estimated self-employment taxes, pay on or before the deadline through the IRS Direct Pay platform or fill out a 1040-ES payment voucher and mail it along with a check for the owed amount to the corresponding IRS address for your state.
2. Organize Your Business Income
Throughout the year, maintain a tidy record of your business earnings, including all invoices fulfilled by clients and relevant bank statements. It’s best to keep your business and personal banking separate, even as a sole proprietor, so there is separation between you and your business financially.
3. Keep Track of Tax Deductions
Just as you keep your earnings organized throughout the year, you should also make sure you have a record of all tax write-offs that you intend to deduct on your annual tax return.
4. Fill Out Form W-9
Have this form filled out and ready to go when clients ask for it. They can’t send you Form 1099-MISC without it, so it’s helpful to have it filed away so you can quickly share your copy when a client requests.
5. File an Annual Return
If you made at least $400 in non-employment income this year, you must file annual taxes as an independent contractor using Schedule C. This is where those well-kept records of your business earnings and deductions will be vital to ensure you avoid overpaying taxes, and only pay what you owe. If you accurately paid your quarterly taxes, ideally you won’t owe anything and may even receive a tax refund!
Frequently Asked Questions about Independent Contractor Taxes
How to Make Filing Taxes Easier
Keeping all of your income and deductions and forms organized can feel like a lot, but with the right tools in your toolkit, it’s actually quite simple! Lili’s Tax Optimizer tools help you categorize your expenses, automatically sets aside a percentage of your income for taxes, and pre-fills your Schedule C form for you, making tax season woes a thing of the past.