The Ultimate Guide to Independent Contractor Taxes
If you’re a DJ, Etsy Shop owner, freelance computer programmer or any of the many other self-employed specialists this guide is for you. We will break down everything from what is a 1099 form to tax deductions. By the time we’re done here, you’ll know everything you need to be confident in handling your independent contractor tax matters.
Who is an independent contractor?
The IRS defines an independent contractor as an individual whose payer has the right to control the direct result of the work, not what will be done and how it will be done.
This concept has made a way for an economy that allows unmatched flexibility for both contractors and those who need things completed.
Sometimes, the line between contractor and employee gets blurred. For example, does working from home and making your own schedule make you a contractor or employee?
Two individuals could perform the same exact task and one identify as a freelance virtual assistant while the other an employee with the job title of administrative assistant. Who decides and how do you know which group you fall into? Well, the IRS provides guidance. They give a few areas in which you evaluate the degrees of control in what you do and how you do it.
This category seeks to determine if there is a reasonable degree of independence and control of the work being done. A question to consider would be, does the payer or company control what is being done and how the worker does the job?
The party responsible for payment, reimbursements or providing the basic equipment and supplies to perform the work is also a key determinant in worker classification.
If there is a written agreement in place and you’re eligible for benefits like vacation, insurance or pension plan it’s likely you’re an employee and not working a 1099 job. The IRS also recommends taking into consideration how long the relationship is expected to last. For example, are you being hired for a one-time project or does the work you do a key aspect of the payer’s business?
It is the payer's responsibility to properly classify workers. If after assessing the nature of your work, you still feel uncertain as to whether you are an employee or contractor, there’s help available. A firm or worker may submit IRS Form SS-8 to request a determination on worker classification. The tax code provides guidance in some areas but not always hard and fast rules. Many situations will need to be evaluated on a case by case basis.
There are different independent contractor classification rules in California.
How does a 1099 contractor get paid?
Independent contractors get paid in all the normal ways that are available to regular employees or businesses. Some may receive payment electronically on a project basis while others may contract their services on an hourly basis. There are also more formal arrangements where there is an agreement in place for services to be provided on an on-going basis for a period of time.
Are you a podcast host or a speaker? Have you provided a service or delivered a program for a school district or private organization. If so, you may have been asked to complete a Form W-9. Form W-9 is used to collect your taxpayer information so that organizations can maintain accurate records and report any payments made to you in a given year on Form 1099.
Many contractors don’t have a designated pay day in the same way an employee would. In some cases they may be paid upon completion of a product or service which for some independent contractors may be daily.
Payday every day is a concept I can get behind!
The main takeaway when it comes to payment, a freelancer has no tax of any kind withheld. We’ll explore exactly which independent contractor taxes you need to be on the lookout for later in the guide.
Your tax liability as an independent contractor
With a federal tax code that’s literally thousands of pages and can be considered an evergreen document due to the frequency of its revisions, it’s easy to be uncertain of exactly what you need to do to comply with the law.
If you work on a platform, you may get some assistance with sales tax if you sell things or local taxes. But generally speaking you’ll want to get familiar with what you’re paying and to whom each tax year.
How much tax do you pay when your'e self-employed?
Let’s start with the portion of independent contractor taxes collected by the IRS. These are known as federal taxes and to keep things simple, there are two parts. There’s the portion that would have shown up on your W-2 pay stubs as FICA, which is collected for the purpose of making contributions to Social Security tax and Medicare taxes. For employees, they pay half and the employer pays half. However, if you get paid and don’t have any taxes withheld, the IRS classifies you as self-employed. You must be aware of how much tax you need to pay on 1099 income.
You see, you are responsible to pay the full amount of self-employment tax which is 15.3%. Fortunately, you’re allowed a tax deduction for ½ of it when you file your tax return.
Next, there’s the Federal income tax. The US follows a progressive tax system where people earning more money are responsible to pay a higher percentage of their income in taxes. The amount you pay will be based on which tax bracket you fall into after you subtract deductions from your total business income. For 2020, there are seven 1099 tax brackets and the tax rate range from 10% to 37%.
To quickly see how much you’ll owe at the end of the year, use Keeper’s self-employment income tax calculator.
State and local tax
As a self-employed tax payer you’ll need to account for your state and local taxes if they apply. Several states don’t have a personal income tax. So if you reside in Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming, you have a bit of an advantage and may be able to save more of your money. For the rest of us, there are free tools available to help in figuring out how much to set aside for 1099 income.
Gig economy taxes
The starting point for independent contractor taxes is income. Income refers to compensation in any form including cash, property, goods or virtual currency. It’ll be up to you to keep track of how much you earn including the value of goods received throughout the year because you’re responsible to pay tax on it even if you don’t receive any documents from the payer.
As a self-employed tax payer, you’re required to file a return once your net earnings are $400 or more. The simple equation for the total amount you’ll have to pay taxes on is Income - Expenses (Deductions) = Net Profit or Loss. If you realize a net profit, that amount will be used to figure the tax you owe.
Check out this self-employed taxes for dummies guide for a simple breakdown of the taxes you'll owe.
Tax deductions for independent contractors
What is a tax deduction? Well, deductions reduce your taxable income and therefore, help you to keep more of your money. They are a big part of the taxable income equation. Deductions take into consideration all that it costs you to run your business or provide a particular good or service.
Employees are not entitled to deduct business expenses, but as an independent contractor, you may. In fact, it’s encouraged! Here’s a list of common deductions that you may be eligible for as an independent contractor.
- Advertising expense
- Car and truck expenses
- Commissions and fees
- Contract labor
- Health insurance (Not including healthcare premiums)
- Home office tax deduction
- Legal and professional fees
- Office supplies
- Rent or leases
- Repairs and maintenance
- Taxes and licenses
- Education expenses
- Phone and internet use (Based on percentage used for business)
For each of the expense types, there are guidelines for how they should be accounted for and sometimes limits to what can be deducted. For example, car and truck expenses cover miles traveled or vehicle(s) used for the purpose of conducting business are deductible. If you use your car a lot for business, you might want to track your miles for taxes. You can opt to deduct actual expenses or take the standard mileage deduction which is adjusted annually.
Some deduction types, like depreciation, come with special rules. Depreciation is an annual income tax deduction that allows you to recover the cost of an asset over the time you use it.
The IRS deems expenses to be deductible if they are both ordinary and necessary. Ordinary refers to whether or not the expense is considered to be common given a particular line of work. Necessary in this sense doesn’t mean required, it refers to an expense that is helpful and appropriate for your line of work.
To illustrate how you could apply deductions in real life let’s consider deductions a freelance real estate agent, photographer, rideshare driver might each be able to take.
For a real estate agent
Felix is a real estate agent. He must have certain licenses and training in order to serve his clients. He could deduct those education classes and professional licensing fees. He can even write-off mileage if he must travel to meet clients. Here is a list of tax deductions for real estate contractors.
For a photographer
Natasha is a photographer. She takes headshots, family photos and is getting into event photography. Natasha may be entitled to a ton of photography tax write offs. She can deduct travel to and from shoot locations, supplies, memberships to professional associations, Insurance on equipment and internet costs.
For rideshare drivers
Jeremy drives for Uber part time. His most obvious deductions for his Uber driver taxes would be his cell phone and expenses related to his car. He can take the standard mileage deduction or use the method that uses actual costs. Jeremy can also deduct amounts spent on supplies, car washes, roadside assistance, and even food and drinks he buys for his passengers.
Keep in mind, personal, living or family expenses are never allowable as deductible business expenses.
When supplies or services are split between business use and personal use, you are only allowed to deduct the portion related to business activity. These rules would generally apply the same for Postmates taxes.
Saving for retirement as an independent contractor
While there has been a surge of people joining the gig economy it’s still a relatively new phenomenon. Whether you got started temporarily to achieve a short term goal or if you’re in it for the long haul, independent contractors retire too. With retirement in mind, there are tax deductions and benefits that come along with any contributions small business owners make. Getting setup with an IRA or 401K may require a little research on your end or working with your tax professional but it’s well worth it.
Are you location-dependent?
Turns out that location matters a great deal when accounting for tax you’ll owe as an independent contractor!
How often do you see people jet setting and sharing their stories of working on a beach in the Caribbean or living half the year out of the and singing the praises of what virtual work has done for the lives of them and their families.
Or perhaps, you’re living your dream as a US citizen and living full-time in Asia. Perhaps you are abroad and you are earning an income as an independent programmer. Such an arrangement could put you in the class of folks who qualify for the Foreign Earned Income Exclusion. It’s a far less common deduction, but this part of the tax code allows you to deduct $101,300 of your foreign earned income.
Because each taxpayer’s line of work is unique and their expenses will be specific to how they run their business it's important to keep good records.
How to keep tax records as an independent contractor
A benefit of being an employee is that there is likely an HR and Payroll department that ensures all of your requisite tax is paid. However you, my friend, are your own boss! Whether all of your income comes from independent contracting or just a portion of it, it’ll be up to you to hold on to your paperwork.
One of the most frustrating aspects of being an independent contractor is having tax season roll around and feeling bewildered by all that must be done. You might feel overwhelmed about possibly being hit with steep penalties and fees (if you miss your tax deadline, it is your responsibility to sort that out with the IRS).
The goal with this article is to make your tax situation and filing your 1099 taxes as seamless as possible while avoiding any tax penalty
Your records should include a summary of all your business transactions and clearly indicate gross income and total expenses.
If you perform work on a platform, they may provide you with an annual statement of activity which makes things quick and easy. For independent contractors who perform work on multiple platforms or operate as a sole proprietorship, you may want to create an email inbox to hold anything that might be needed when it’s time to organize your tax information. Remember, tips and cash payments also need to be accounted for.
Depending on the kind of work you do, managing expenses may require a little more planning. I get it, it’s easy to forget about the ink cartridge you bought last minute, or the expedited shipping you paid for to make sure an order arrived in time.
Keeping all of your paper receipts for taxes is a myth. After all, a good number of them are almost useless because the ink will probably fade away. There are easier options like keeping credit card records for tax purposes.
When you’re on the go and get a receipt for something that’s business-related, just snap a photo of it. After you take a picture, simply email it to yourself to be placed in that tax folder we talked about earlier.
You can make your life a lot easier by tracking your deductions with an automatic 1099 expense tracker app!
Estimated payments and calculating your taxes
Estimated payments are required for individuals, including sole proprietors only if you expect to owe $1000 or more when your return is filed.
Schedule SE or form 1040-ES is used to figure and pay estimated tax. However, the easiest way to file quarterly taxes is electronically. There are options through the IRS website (IRS Direct Pay), EFTPS (Electronic Federal Tax Payment System or IRS2go app. There are tools available to help you figure out exactly how much you should expect to pay like Keeper’s estimated tax payment calculator.
If you think you’ll owe tax and you also have W-2 income you can choose to adjust your withholdings to cover the overage. If you earn all of your income as an independent contractor, don't expect a tax refund. You'll be expected to owe and you may want to make quarterly estimated payments. Quarterly tax payments allow you to pay as you go as the tax system was designed and can help to avoid a large unexpected tax bill when you file your return.
When are quarterly estimated tax payments due? Well, quarterly tax payments are due on a schedule set by the IRS. Those dates are April 15, July 15, September 15 and January 15.
Filing your taxes as a contractor
At this point, you know which small business taxes you need to pay, you have to pay close attention to your expenses and you need to get ready to file your tax return with the IRS.
1. Collect your documents
As an independent contractor, you may receive a 1099-K or form 1099-MISC, you’ll want to make sure you have those on hand. You may also have W-2 income, interest or dividend statements and you’ll need all of that information ready for you in one place once it’s time to prepare your taxes.
2. Organize your records
The records you or your bookkeeper maintain is a critical part of the process. This is where all the receipts you’ve maintained throughout the year show up and count for something. You should want to take advantage of every allowable deduction and an accurate summary of what you spent will help you do that.
3. File your Tax Return
The final step in the process is to file your return. If you’ve gotten to this point, you know that a little planning when it comes to your independent contractor taxes goes a long way. The most efficient way to submit your tax return is to e-file. If you happen to be filing an amended return for 2019, that can be e-filed as well. Any other amended returns will have to be sent by mail. Use Schedule C (Form 1040 or 1040-SR) to report income or loss from your business.
Getting set up for success
Running a business means you wear a lot of hats. Managing what you owe to the government can seem like a lot. Here are a few tips to keep you on track with your taxes and to hopefully avoid an IRS audit notice.
Put your system in place and in the beginning especially, and handling your tax obligations becomes simple.
1. Set up the right bank accounts
Maintaining a separate bank account will help you keep business and personal expenses separate. This also helps with the record keeping part of things. While you’re at the bank, set up a separate savings account too. It’ll make it even easier to transfer your 25 to 30 cents for every dollar you earn to pay for taxes.
2. Use software and apps
Depending on your industry there are software and apps to help you track almost anything. Whether it be mileage, sales and returns on merchandise sold, or even tax details. These tools help you stay organized and compliant so find what works for you. nf act, there are many great reviews for Keeper Tax that shows the tool can help you do that.
3. Schedule a mid-year check-in
Conducting a mid-year check-in can help you get a sense for how your business is doing and give you the information you need to make adjustments to your tax plan if needed. Perhaps you earned a lot more than you originally estimated and need to set aside more for taxes. Reviewing your documents mid-year also saves you the headache of having to go through an entire year of receipts a week before taxes are due and potentially missing deductions.
The freelancer tax preparation checklist
Here is our 1099 taxes checklist.
- Maintain records of all income received (including cash, tips and value of goods received)
- Keep track of business expenses (you can this free 1099 excel template or our app to automatically do it for you)
- Plan to make estimated tax payments if necessary
- File annual tax return
- Pat yourself on the back for a job well done after completing all of your tax forms!
Always keep in mind that each taxpayer has a unique set of circumstances. If you have questions or need advice about your specific situation during tax time reach out to your tax professional.
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At Keeper Tax, we’re on a mission to help freelancers overcome the complexity of their taxes. That sometimes leads us to generalize tax advice. Please email firstname.lastname@example.org if you have questions.