The IRS classifies independent contractors as professionals who work on behalf of others while controlling the project outcome. Most contractors are small business owners operating as sole proprietorships, partnerships, LLCs, or S Corps. Running any of these entities makes you eligible to pay income tax on your earnings.
How Is an Independent Contractor Different from an Employee?
The essential feature of independent contractors is that they retain significant control over their projects. Several occupations offer this flexibility and convenience. Examples of professionals who may work as independent contractors include accountants, hairstylists, electricians, interior decorators, dentists, attorneys, and freelance writers.
As an independent contractor, various factors set you apart from an employee. For instance, you can specify your hours and rates, own your own job tools or supplies, and accept more than one job at a time. Employees typically don’t enjoy such flexibilities.
How Do Independent Contractors Receive and Report Income?
While employees receive a regular paycheck, independent contractors have unique payment terms. Your agreement with each client includes details on when you’ll receive payment and how the transaction will occur. Tax authorities don’t consider these payments as wages or salaries because the project owner doesn’t deduct taxes.
During tax season, the client should provide a Form 1099-MISC. It details all the money they paid you during the preceding calendar year. This requirement isn’t necessary for earnings under $600, although you still have to report the income. Form 1099-MISC is comparable to a W-2 for employees.
You’ll receive multiple copies of Form 1099-MISC if you work with several businesses throughout the year. The IRS requires payers to complete and postmark these forms by the last day of January each year.
Filing Taxes as an Independent Contractor
The IRS treats independent contractors as self-employed professionals. You must file tax returns if you earn at least $400. In addition to Form 1040, you should also submit a Schedule C showing your business’ net income or loss. A Schedule C-EZ is appropriate if your business expenses for the year were under $5,000.
You’re also required to submit self-employment tax, which makes up 15.3% of your net earnings. Of this tax, 12.4% covers social security, while 2.9% goes towards Medicare. Form 1040 includes Schedule SE to help you calculate the self-employment tax you owe. Although this article focuses mainly on federal taxes, you might also have to pay local and state taxes depending on your location.
Are Independent Contractors Eligible for Tax Deductions?
You can lower your taxable income by claiming some business expenses as deductions. Examples include business insurance, advertising, home office expenses, equipment purchases, business-related travel, and legal costs.
Deductions also apply to personal expenses such as mortgage interest, student loan interest, and real estate taxes. Some self-employed retirement plans are also eligible. They include solo 401(k)s, SEP IRAs, and SIMPLE IRAs.
It may be tempting to file taxes on your own as an independent contractor. However, it makes more sense to hire a professional. Financial experts like CPAs, enrolled agents, and qualified financial advisors can help you file accurately and promptly, as well as benefit from various tax exemptions, credits, and deductions. Their fees are worth the convenience and overall cost savings you’ll enjoy.