What is an Independent Contractor?
Independent contractor or a freelancer is a person or entity contracted to perform work or provide services to another entity, but not as an employee. They pay their own Social Security and Medicare taxes. Internal Revenue Services (IRS) classify doctors, dentists, veterinarians, lawyers, and many other professionals who provide independent services as independent contractors. It also includes contractors, subcontractors, freelance writers, auctioneers, actors, musicians, and many others who provide independent services to the general public.
The employer does not have direct control over the worker, he can only control the quality or result of the job and not the method through which the work is done. For taxation purposes, their default designation is “sole proprietor” or a form of small business. The taxpayer must correctly classify each payee as either an independent contractor or an employee.
Filing of Taxes
Generally, an independent contractor’s income is the compensation received for doing work or providing services and is considered as business income, not a salary or wages. You must pay taxes on all the income of your business. The payments you received do not have any federal tax withholding and deductions on Social Security and Medicare are not allowed. But you still need to pay federal and state income tax based on the business income. The taxes of Social Security and Medicare must also be paid, combined with the self-employment tax for independent contractors.
In the United States, they are considered sole proprietors or single member limited liability companies (LLCs). For personal income taxes, you need to prepare Form Schedule C of Form 1040 and list down business income minus the expenses of the contracted work. IRS says that deductible expenses must be clear for the business, not personal and it must be documented – with date, amount and business purpose.
Quarterly Estimated tax
The profits or losses from rental properties must be reported on Schedule E of Form 1040. Quarterly, they must submit Form 1040-ES for self-employment taxes to IRS. For business profit, you need to make an estimated payment of your business taxes and it covers both federal income taxes and self-employment tax you owe for Social Security and Medicare. In the current year, independent contractors pay 12.4% in Social Security contributions and 2.9% in Medicare payments on the first $128,400 of their earnings. If you have another source of income other than business, you may increase the withholding on income from a job to account for the additional income tax and self-employment taxes you have to pay. In the calculation of the estimated tax due, Schedule C-EZ and Schedule SE might be of great help.
If you receive Form 1099-MISC instead of W-2 which shows the amount you earned from each client for a year. A common reason you will receive tax form 1099-MISC is if you are self-employed or did work as an independent contractor during the previous year. But some clients will issue 1099-Misc forms to their contractors if the amount paid warrants that expense. If an independent contractor earns less than $600 from one client, that payer will not receive a 1099-MISC form but still required to include the amount paid on your business tax return. If an independent contractor earns more than $600 from a single client, that payer is required to issue the contractor a 1099 form detailing their earnings for the year.
When received a 1099-MISC rather than a W-2 you can claim deductions on your Schedule C, which you use to calculate your net profits from self-employment. The deductions must be for business expenses the Internal Revenue Service considers ordinary and necessary for your self-employment activities. An expense is considered necessary if it is helpful to you in completing your work. If your deductible business expenses are $5,000 or less, you can file a shorter Schedule C-EZ. You can use Schedule C or C-EZ, you will calculate your net profit by taking your total self-employment income, including those earnings not reported on a 1099-MISC, and subtracting the deductible business expenses you incur. The final net profit must be transferred to Form 1040 and combined with your other earnings to calculate your taxable income.
As a self-employed person, you are required to report your self-employment income if the amount you receive from all sources totals $400 or more. In this situation, the process of filing your taxes is a little different than a taxpayer who only receives regular employment income reported on a W-2.
Independent contractors must be tax knowledgeable for them to be guided and avoid incurring tax penalties.
