Independent contractor, freelancer, gig worker, 1099 employee—there are lots of ways to say the same thing: You’re self-employed. That’s right, you’re your own boss . . . and a lot of times, your own tax guy (or gal).
Some common professions for independent contractors include: accountants, writers, electricians, ride-share drivers, landscapers, lawyers, hairstylists and doctors. While independent contractors come from many different walks of life, they have something in common: a tricky tax situation.
Independent contractor taxes can be difficult, but we’re here to walk you through everything you need to know to win when it comes to tax time.
What Is an Independent Contractor?
The IRS classifies workers into two categories: employees and nonemployees (independent contractors). Yep, you’re either one or the other . . . or you’re unemployed.
Employees receive company benefits, have payroll taxes withheld from their paychecks, and receive a W-2 at the end of the year that lists how much money they earned and how much taxes were withheld. (They also have to laugh at their boss’s jokes.)
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Independent contractors work for one or more companies and don’t receive benefits or have payroll taxes withheld from their checks. At the end of the year, the companies they work for send them a 1099 instead of a W-2. (We’ll talk more about that in a minute.)
The IRS has a bunch of rules for determining if someone is an employee or an independent contractor, but the general rule is that you’re an independent contractor if a company assigns you work but does not direct or control how you do it.1 Basically, if you’re a contractor, you don’t have to show up at an office at a certain time each week or work on a specific schedule. You probably miss out on water-cooler talk too . . . which isn’t necessarily a bad thing.
How Is Independent Contractor Income Paid and Reported?
Independent contractors get paid in any number of ways: checks, cash, direct deposits, digital payments (Venmo, PayPal, etc.). Some companies pay contractors by the hour and others pay them by the project. The IRS does not classify this money as a salary or wages because only W-2 employees earn a salary or wages. It’s simply called income.
Independent contractor income is usually reported on a 1099-NEC (the NEC stands for nonemployee compensation) or a 1099-K. These little tax forms list how much money you earned as a contractor so you can report it on your taxes. Any companies you did more than $600 of work for should send you a 1099 at the end of the year.2 But even if you don’t receive a 1099 because you earned less than $600, you’re still supposed to report that income to the IRS.
If you’re a prolific independent contractor—say you’re a freelance writer and work for a bunch of different publications—you could end up with a pile of 1099-NECs. Make sure you gather them in a safe place because you’ll need them when it comes time to file your taxes. (Hint: The leaning tower of unopened mail on your desk is not a safe place.)
How Does an Independent Contractor Pay Taxes?
There are two certainties in life: death and taxes. Whether you’re an independent contractor or a normal employee, you have to pay taxes. The big difference is that independent contractors have to make direct tax payments to the IRS because they don’t have an employer who withholds taxes from their paycheck.
Quarterly Estimated Tax Payments
Not having taxes withheld from your paycheck on a regular basis means you could rack up a pretty big tax bill by the end of the year. Because of this, the IRS requires contractors who expect to owe more than $1,000 in taxes at the end of the year to pay quarterly taxes. This means you must estimate your income and tax liability and send a tax payment to the IRS every few months.
If you don’t make estimated payments and end up with a tax bill over $1,000 at the end of the year, the IRS will hit you with fees and penalties for underpaying your taxes. You never want to end up on the IRS’ bad side, so make sure you’re paying enough taxes. A good rule of thumb is to set aside 25–30% of every paycheck for taxes if you’re self-employed.
Independent Contractor Tax Deadlines
The due dates for estimated payments (as long as they don’t fall on weekends or holidays) are: April 15, June 15, September 15 and January 15.3
Even if you make quarterly payments, you’ll still need to file your annual tax return like everyone else on April 15 (April 18 in 2022 due to a holiday). If you live in a state or city that has income taxes, check with your local government for specific guidelines for estimated payments.
The self-employment tax is the big spoiler when it comes to being an independent contractor. This 15.3% tax is made up of both the employee and employer portions of Social Security and Medicare taxes (sometimes called FICA).
Everyone who works has to pay FICA taxes on their wages. But the difference between being self-employed and being employed by a company is that employers are required to foot the bill for half (7.65%) of FICA. So if you’re self-employed, you’re stuck paying the full 15.3%. Ouch!
You’ll need to fill out Schedule SE to figure out how much you owe in self-employment taxes.
Tax Deductions for Independent Contractors
The key to lowering your tax bill is through tax deductions, and there are a bunch of them for independent contractors. One of the largest deductions you can take is the home office deduction, which allows you to deduct a portion of your home’s expenses (mortgage, insurance, utilities, etc.). Other common deductions are vehicle use (58.5 cents per mile, baby!), office supplies, equipment, phone and internet service, and travel and meals.4 Our list of 16 self-employment tax deductions will save you money!
To claim any of these deductions, you’ll need to fill out a Schedule C tax form. This two-page form is for reporting profit or loss from business. Hopefully you made a profit!
Example of Independent Contractor Taxes
We’ve covered a lot of ground, so let’s take a look at an example to try to clarify it all.
Bill Shakespeare is a freelance writer who wrote four plays for four different theater companies in 2021. At the end of the year, each of the theater companies sent Bill a 1099-NEC form that listed how much they paid him for his work. The total is $80,000. Hey, who says artists have to starve?
Bill will include all the income he earned on Part I of Schedule C. So that’s pretty simple: $80,000.
In Part II, he’ll subtract or deduct all of his business expenses from his income. Let’s say his home office takes up 20% of the space in his home. That means he can deduct 20% of his mortgage, insurance and utilities. We’ll keep it simple and say that equals $3,500.
And then he bought a $2,000 laptop (used exclusively for business) and spent $5,000 traveling (by car and plane) to the theater companies. That comes to a grand total of $10,500 in expenses.
Income – expenses = profit, so in Bill’s case, $80,000 - $10,500 = $69,500 in profit.
Bill’s next step is to take his net profit and plug it into Schedule SE to figure out how much he owes in self-employment taxes. Remember, the self-employment tax is 15.3%, so that means Bill will owe $10,633.50. The IRS gives you a little break on your self-employment taxes—they let you deduct the portion your employer would’ve paid. So that will knock down Bill’s tax bill a bit.
After that, Bill will move on to the 1040 tax form and begin the process of figuring out the rest of his income taxes.
Since Bill owes more than $1,000 in self-employment taxes—and that’s not counting income taxes he’ll owe based on his tax bracket once he’s done filling out his 1040—he should have made quarterly estimated tax payments to avoid IRS penalties.
Filing Your Taxes: DIY or Hire a Pro?
Did you get lost in the weeds? An Endorsed Local Provider (ELP) can guide you through your tax situation no matter how complicated it seems. They’re RamseyTrusted and know tax code so you don’t have to. Find a tax pro in your area now!
Being an independent contractor makes doing your own taxes more difficult, but it’s not impossible. If you’re a do-it-yourselfer, Ramsey SmartTax is the tax software for you. It’s easy to use and has up-front pricing. Check out Ramsey SmartTax today.