If you’re considering becoming an independent contractor, or are one already, it helps to be familiar with the taxes you’ll be required to report and pay so that you can plan for tax time.
What Is an Independent Contractor?
An independent contractor (IC) is someone who directly offers services to the general public. Independent contractors may be people who work in professions—dentists, doctors, or attorneys. They may also work in such trades as plumbing, building contracting, or electrical work. They may also include other types of service workers or gig workers such as rideshare drivers or freelancers. You don’t have to register your business as a specific type to be an independent contractor. For tax purposes, the default business type is a sole proprietorship—a one-person business that isn’t formed as a corporation. The other common business type for ICs is the single-member (owner) limited liability company (SMLLC).
What Taxes Do Independent Contractors Have To Pay?
As a self-employed individual who is in business as a sole proprietor, you have several types of taxes to pay:
Self-Employment Tax
Everyone who works in the U.S. must pay Social Security and Medicare taxes. For independent contractors and others who are self-employed, these taxes are called “self-employment taxes.” These taxes are based on your business’s net income (profits). The self-employment tax rate is 15.3% with 12.4% going to Social Security and 2.9% to Medicare. You can take a deduction for half of the total, equal to the amount that an employer would pay for these taxes. Each year, the Social Security part is capped at a specific maximum. If your combined earnings as an IC and as an employee are greater than $200,000 for the year, you must pay an additional Medicare tax of 0.9% on your combined earnings as an IC and as an employee (if this applies). You’ll need to use Schedule SE to calculate the total self-employment tax you owe. Then, you must add this amount to your personal tax return (Form 1040/1040-SR).
Federal Income Taxes
Independent contractors are considered to be business owners. The government requires that you include on your return any personal income you make from your business, along with business tax deductions. Most independent contractors are sole proprietors or single-member LLCs who report their federal income taxes on Schedule C as part of Form 1040. Calculate your business income, and take deductions on Schedule C to find your net profit or loss total that is added to other sources of income (from employment or investments, for example) to get your net taxable income for the year.
State Income Taxes
You must also report and pay state income taxes on your business income in most states. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming don’t have a state income tax. New Hampshire doesn’t tax earned income, but it does tax interest and dividends. Contact your state’s tax agency for information on how its income taxes work.
Estimated Taxes
As a business owner, you usually don’t have amounts withheld from pay for income taxes and Social Security/Medicare taxes during the year, as employees do. You can use the tax worksheets on IRS Form 1040-ES to calculate estimated taxes and self-employment taxes. You must pay estimated taxes during the year to avoid penalties for underpaying. In most years, and for most taxpayers, the due dates are April 15, June 15, September 15, and January 15 of the next year.
Employment Taxes
If you have employees, you must withhold federal income taxes from employees, pay several types of employment taxes, and file tax reports to the IRS and the Social Security Administration (SSA). You and your employees must each pay half of FICA taxes for Social Security and Medicare. The rate is the same as self-employment tax (15.3%), based on the employee’s taxable income. You withhold the employee part from employee paychecks and set aside your part as the employer to pay to the IRS. You must pay FICA taxes and federal income tax withholding at least monthly and report quarterly on IRS Schedule D, Form 941. Employers pay federal and state unemployment taxes to fund unemployment benefits for employees who lose their jobs. Employees don’t pay that tax. The rate is 6% on employee wages above $1,500 in any calendar quarter. You’ll need to complete IRS Form 940 to report and pay those taxes each year.
Tax Deductions for Independent Contractors
You can reduce your business income by taking deductions for business expenses. To be deductible, these expenses must be for the purpose of making a profit. They must also be ordinary (common) and necessary (helpful and appropriate). See the list of allowable expense deductions on Schedule C. Here are some important deductions you may be able to take, depending on your business situation. “Cost of goods sold” is a separate calculation on Schedule C for materials, labor, shipping, and other costs for producing products for resale. Home business costs are for the space you use as a home office or for other business uses. You can only deduct the space you use regularly and exclusively (only for business purposes). This deduction is calculated on IRS Form 8829 for actual expenses or Schedule C using a simplified method for smaller spaces. Business driving expenses are deductible in your independent contractor business. If you use a vehicle for both business and personal driving, you can only deduct business use, using either actual expenses or a standard mileage rate that changes every year. Report these expenses on Schedule C. If your business owns major assets, like a car, a building, furniture, or equipment, you can deduct the costs over several years. This process, called “depreciation,” is a non-cash deduction that is reported separately. Use IRS Form 4562 to calculate depreciation and report it on Schedule C.
How To File Income Taxes as an Independent Contractor
Before you begin the process of filing your business income tax return, you’ll need information on your income and expenses for the year. Prepare a profit-and-loss statement (also known as an “income statement”), and retain detailed records of expenses to support all of the deductions you want to take. Many small businesses use business tax preparation software that walks you through the various sections of Schedule C, Schedule SE, and other schedules and forms to include business information on Form 1040.
Tips for Filing Taxes as an Independent Contractor
Here are some tips to help you cut your tax bill and avoid tax audit issues.
Lowering Your Business Tax Bill
No one likes paying income taxes, but you can keep your business tax bill lower by deducting all legitimate expenses possible. In addition to taking all of the deductions possible, you may be able to apply for tax credits for various business activities. Some examples are a work opportunity tax credit for hiring disadvantaged workers or credit for giving employees health insurance.
Recordkeeping From Startup to Tax Filing
You don’t have to show all of your business records when you file your tax return, but what if you are audited? The IRS looks carefully at deductions for driving expenses and home business space, among other areas, so it’s important to keep excellent records. For example, with driving expenses, you must keep at-the-time records that include the date, mileage, and business purpose.
Getting Help with Independent Contractor Taxes
Business taxes are complex, and there are many qualifications, limits, and exceptions to consider. For instance, even a seemingly simple deduction, like the one for business use of your home, has many issues. Finding a licensed tax professional to help you with your business taxes can save you money and help you survive a tax audit. You must use the EFTPS system or another IRS-approved online method to pay federal employment taxes, including FICA taxes and federal unemployment taxes.
Your filing statusAny withholding amountsYour sources of income for the year, including your self-employment income
You can use this calculator from the IRS to see whether you need to file a federal tax return. You can make up to $400 per year in self-employment earnings and not have to pay self-employment taxes.
