What is an independent contractor?
An independent contractor (IC) is a person who provides services directly to the general public. Independent contractors can be individuals working in professions – such as dentistry, medicine, and law. They may also work in fields like plumbing, construction contracting, or electrical work. They may also include other types of service workers or gig workers, such as ride-sharing drivers or freelancers.
What taxes do independent contractors need to pay?
As a self-employed individual working as a sole proprietorship, you are required to pay several types of taxes:
Self-Employment Tax
Everyone working in the United States must pay Social Security and Medicare taxes. For independent contractors and other self-employed workers, these taxes are called “self-employment taxes.” These taxes are based on your net earnings from your business (profits). The self-employment tax rate is 15.3%, of which 12.4% goes to Social Security and 2.9% to Medicare. You can deduct half of the total amount, which is equivalent to what an employer would pay for these taxes.
Federal Income Taxes
Independent contractors are considered business owners. The government requires you to include any personal income you earn from your business on your personal tax return, along with business tax deductions. Most independent contractors are sole proprietors or single-member LLCs (SMLLCs) who file federal income tax returns on Schedule C as part of Form 1040. Calculate your business income and deductions on Schedule C to determine the total net profit or loss that gets added to other income sources (such as from employment or investments) to arrive at the net taxable income for the year.
State Income Taxes
You also need to report and pay state income taxes on your business income in most states. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming do not impose a state income tax. New Hampshire does not tax earned income, but it does tax interest and dividends. Contact your state tax agency for information on how state income taxes work in your state.
Estimated Taxes
As a business owner, there are usually no withholdings from your paychecks for income taxes and Social Security/Medicare taxes throughout the year, unlike employees. You can use the tax worksheet in IRS Form 1040-ES to calculate your estimated taxes and self-employment taxes. You must pay estimated taxes throughout the year to avoid penalties for underpayment. In most years and for most taxpayers, deadlines are on April 15, June 15, September 15, and January 15 of the following year.
Employment Taxes
If you have employees, you must withhold federal income taxes from employee paychecks, pay several types of employment taxes, and submit tax reports to the Internal Revenue Service (IRS) and Social Security Administration (SSA). You and your employees must pay half of the FICA taxes for Social Security and Medicare. The rate is calculated at the same percentage as the self-employment tax (15.3%), based on the employee’s taxable income. You withhold the employee portion from employee paychecks and retain your portion as the employer to pay to the IRS. You must pay FICA taxes and federal income tax at least monthly and file quarterly reports on Schedule D to the IRS and Form 941.
Tax Deductions for Independent Contractors
You can reduce your business income by deducting business expenses. To be deductible, these expenses must be for the purpose of generating profit. They must also be ordinary (common) and necessary (helpful and appropriate).
See the list of allowable deductions on Schedule C. Here are some important deductions that you may be able to take advantage of, depending on your business circumstances:
- Cost
- The cost of goods sold is a separate account on Schedule C for materials, labor, shipping, and other costs of producing products for sale.
- Home office expenses are for the space you use as a home office or for other work-related purposes. You can 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 can be deducted. If you use a vehicle for both business and personal driving, you can only deduct the business use, using either actual expenses or the standard mileage rate, which changes every year. Report these expenses on Schedule C.
- If your business has capital assets like a vehicle, building, furniture, or equipment, you can deduct the costs over several years. This process is called “depreciation,” which is a non-cash deduction reported separately. Use IRS Form 4562 to calculate and report depreciation on Schedule C.
Note: Independent contractors can also benefit from a 20% tax deduction called “Qualified Business Income Deduction,” based on net business income. You can use IRS Form 8995 to calculate this deduction and add it to your Form 1040.
How to File Income Tax as an Independent Contractor
Before you begin the process of filing your business income tax return, s
Source: https://www.thebalancemoney.com/how-to-report-and-pay-independent-contractor-taxes-5197419
Leave a Reply