An Independent Contractor’s Guide to Filing Taxes
Thinking about becoming an independent contractor? One of your first considerations is probably taxes. And rightly so; the process of filing and paying taxes as an independent contractor is both different and more complicated than that of a W2 employee.
At Wood CPA, we’ve helped many independent contractors with tax planning and tax filing. Here’s everything you need to know about filing taxes as an independent contractor.
Key Takeaways:
- Independent contractors file taxes differently than W-2 employees, using Schedule C with their 1040
- You may need to make quarterly tax payments to avoid gross underpayment penalties
- Self-employment tax is a key part of independent contracting
- Proper record-keeping and maintaining a separate business account is essential
- Many tax deductions are available (but should be documented properly)
What is an Independent Contractor?
As an independent contractor, you are a self-employed individual who is not employed by any company. Instead, you are contracted out to provide services or perform work for individuals, companies, or other entities.
How Independent Contractor Taxes Differ from Employee Taxes
Whether you’re picking up some freelance work on the side or quitting your day-job to become a full-time 1099 independent contractor, you need to thoroughly understand your new tax obligations. This will help you feel confident throughout the year so you can focus on what matters most: running your business.
There are two forms you need to be aware of, the 1099-NEC and form 1040 (Schedule C). Each independent contractor tax form is designed to help you accurately report your business income.
1099-NEC
The first thing to understand is that instead of getting a W-2 form from an employer, you’ll now receive 1099-NEC forms from your clients.
The “NEC” stands for “Non-Employee Compensation” — this is the specific form used to report payments to independent contractors if the total payments are more than $600.
(Note: 1099-MISC used to be used for this purpose, but tax law changed in 2020. Contractor payments made in 2020 and beyond are reported on the form 1099-NEC.)
And remember, the IRS expects you to report ALL your income, even if you don’t receive a 1099-NEC for it.
Schedule C (Form 1040)
So where do you report your business earnings? As an independent contractor, you’re still filing your personal taxes by April 15, just like everyone else. The main difference is that you’ll need to file Schedule C along with your personal return.
Schedule C is where you’ll report business income and expenses.
The Self-Employment Tax
One of the most important things to know about 1099 contractor taxes is the self-employment tax. This tax is basically the equivalent of Medicare and Social Security taxes that you’d pay as an employee.
When you were just an employee, your employer would cover half of those taxes and you would cover the other half (those are the deductions you would see on your paystubs).
But as an independent contractor, you’re both the employee and the employer, meaning you now foot the entire bill. That amounts to 15.3% (12.4% for Social Security and 2.9% for Medicare).
The good news? You can deduct half of your self-employment tax on your tax return. More on deductions later.
All About Quarterly Tax Payments
Wait — independent contractors have to pay taxes four times a year?
Yes, most of the time. Let me explain:
The U.S. government has a pay-as-you go tax system, meaning they like to receive money throughout the year. Now, when you’re an employee, your employer is responsible for withholding taxes from your paycheck and regularly making payments to the government.
As an independent contractor, you’re now your own employer. That means you need to make those payments yourself on a quarterly basis.
Is it mandatory? Well, it depends. If you expect to owe $1,000 or more in taxes for the year, you generally need to make quarterly payments to avoid underpayment penalties.
However, if you have a regular job with tax withholding and your contracting work is just a side gig, you might be covered by your regular withholding.
Quarterly Tax Deadlines:
The main tax deadline is still the same: April 15, with an optional extension to October 15.
The quarterly tax deadlines are:
- April 15: for income earned from January through March.
- June 15: for income earned in April and May.
- Sept. 15: for income earned from June through August.
- Jan. 15: for income earned from September through December in the prior year.
Don’t forget that if your state has income taxes, you’ll also need to make estimated tax payments to your state.
How to Calculate Your Independent Contractor Tax Rate: Safe Harbor
So what is the tax rate for an independent contractor? How do you decide how much to pay every quarter?
Your tax rate as an independent contractor will depend on the tax rate for your tax bracket plus the self employment tax. But here’s the catch: Many independent contractors don’t know in advance how much they’ll have made for the entire year. That means they don’t know their tax bracket or tax rate.
That’s why, for my IC clients, I use the safe harbor rule to determine their quarterly tax estimates.
The safe harbor rule uses the prior year’s return to determine how much you should pay quarterly, thereby avoiding underpayment penalties. It may not be accurate for what you really owe, but if you make those quarterly payments, you’ll be guarded against any penalties.
Here’s the safe harbor formula:
If your income is $150,000 or less: Pay at least 100% of last year’s tax.
If your income is more than $150, 000: Pay at least 110% percent of last year’s tax.
Independent Contractor Tax Deductions
Now for some good news: Independent contractors often have access to more tax deductions than regular employees. Now your actual deductions may vary based on what kind of service you’re offering, but in general, here are some common deductions you might be able to take:
- Home office space
- Portion of cell phone and internet bills
- Business mileage
- Software subscriptions
- Business insurance
- Equipment purchases
If you’re purchasing something specifically because you need it for your business, it’s probably deductible. But remember, if you’re planning on deducting it, you need to keep records of your purchases and payments.
How To Keep Great Records
Deductions are a great way to lower your tax bill as an independent contractor. But without some organized system of keeping receipts and records, you’re going to have a stressful time trying to file your taxes.
And trust me, no tax professional wants to see a box of receipts at tax time, either!
Not sure how to keep good records? I recommend:
- Setting up a separate bank account for your business
- Using accounting software like QuickBooks or a detailed spreadsheet
- Tracking your business miles
- Keeping digital copies of all receipts
- Documenting the business purpose of expenses
For those partial expenses like internet and cell phone use, keep track of what percentage is used for business. If you work 40 hours a week from home, that might justify claiming about 24% of your internet bill as a business expense.
Common Mistakes to Avoid as a New Independent Contractor
Over the years, I’ve seen contractors make many of the same mistakes, including:
- Missing out on legitimate deductions because they didn’t know about them
- Being too aggressive with deductions (no, you can’t deduct 100% of your cell phone bill if you also use it personally)
- Forgetting to make quarterly tax payments
- Not reporting all income
- Poor record-keeping
It’s important to remember that in your first few years of independent contracting, mistakes will be made, and that’s OK! As long as you’re doing your research and putting in an effort to understand tax laws around independent contracting, you’ll be just fine.
And if you’re still unsure about how to do taxes as an independent contractor, it may be time to get the help of an industry expert.
Let Wood CPA Handle Your Independent Contractor Taxes
At Wood CPA, we’ll help you make the best decisions for your business to keep you feeling confident and penalty-free. We help independent contractors by:
- Setting up proper record-keeping systems
- Calculating their quarterly tax payments
- Identifying all possible deductions
- Filing accurate tax returns
- Planning for future tax obligations
If you’re feeling overwhelmed and still don’t fully understand how to file taxes as an independent contractor, we’re here to help. Let Wood CPA take the stress out of independent contractor taxes so you can get back to running your business. Contact us today to schedule a consultation!
Image Credit: Doing Taxes Stock photos by Vecteezy
