Your tax payment as an independent contractor could be a little tricky. You must file extra forms, ensure you pay Uncle Sam enough in the year, and pay your self-employment tax.
Who is an Independent Contractor?
Your business structure will determine if you qualify as an independent contractor. There are rules and tests from Uncle Sam that can guide one towards such a decision. However, a business that can control the work performed might qualify as an independent contractor at a larger level.
Uncle Sam classifies all independent contractors as self-employed. An independent contractor can operate as a sole proprietor, a Limited liability company or an S corporation. Since many US businesses are run as sole proprietorships, this article will focus on the business structure.
Reporting Your Self-Employment Income
The manner of reporting income as an independent contractor differs from how an employee will report it. An independent contractor will have to file Schedule C with the personal tax return. You will have a detail of your business profit and loss in Schedule C.
Since an independent contractor is classified as self-employed, such as running a one-man business, the income you earn as an independent contractor needs to be reported on Schedule C. There will also be payment of income tax on the entire profit.
Deductions
Even though an independent contractor pays more self-employment tax, there is a bright side – the possibility of taking business deductions. Such business deductions reduce the profit amount on which your income taxes will be based.
Such deductions will be reported with your income on Schedule C. As an independent contractor, you qualify for some business deductions like home office deduction, health insurance, phone bill deductions and others.
Based on the TCJA ruling, there are other deductions that an independent contractor might qualify for – specifically the qualified business income deduction. With this, you can deduct 20% of the income from your business.
Self-Employment Taxes
One of the financial cons of being self-employed is self-employment taxes. These are the equivalent of the Medicare and Social Security Taxes. As an employee, your employer will cover half of such taxes. However, a self-employed person will be responsible for the entire tax.
Sadly, such self-employment tax indeed adds up. Currently, Medicare is 2.9%, and social security is 12.4%, which gives 15.3% for self-employment tax. Even though you are responsible for the entire 15.3%, the silver lining is that you can collect half of what you pay as an income deduction.
Quarterly Estimated Tax Payments
The United States operates a pay-as-you-go tax system. This implies your tax payment must be regular in the year. As an employee, your boss will withhold income tax from your pay and send it to the IRS.
An independent contractor, on the other hand, pays the government directly and regularly throughout the year. This happens through the estimation of your income tax every quarter of the year. You estimate what you need to pay the government by guessing your entire income for the year or use what you paid as estimated taxes for past years.
Knowing the exact amount you owe as tax will be possible unless you file the personal tax return when the year ends. However, you need to estimate this because underpayment can lead to penalties. Also, don’t forget the state estimated taxes as well. Besides making estimated payments for the federal government, ensure you pay the state throughout the year.
1099-MISC
An employee will generally get a W2 every year that reveals the total income and what was withheld from the paycheck.
For an independent contractor, on the other hand, you will get a 1099-MISC. The form will reveal the entire amount you got paid in the year. With such information, you can be sure you report all income earned in the year.
People who earned below $600 from a client in the year might not receive a 1099-MISC; however, reporting such income is important on Schedule C.
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