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There are a lot of advantages to being your own boss: you get to pick and choose the clients you want to work with, structure your own schedule, and even work in the comfort of your own home. But along with all of the job perks of being an independent contractor, come some extra responsibilities and challenges…one of which being self-employment taxes (cue the Jaws theme song). Figuring out when and how to pay your self-employment taxes requires a little bit of tax know-how and preparation, but don’t worry — we’re here to help!
In this definitive guide, we’re discussing when and how to file your independent contractor taxes, as well as answering some important FAQs to give you a more comprehensive view of what to expect when freelancing. Need answers fast? Use the links below to navigate.
- Key Tax Terms
- When to Pay Taxes as an Independent Contractor
- How to Pay Independent Contractor Taxes
- Independent Contractor Tax FAQs
- What to Know Before Hiring an Independent Contractor
- Help Filing Independent Contractor Taxes
Key Tax Terms
Before we jump into the nitty gritty of independent contractor taxes, let’s establish some baseline tax term knowledge.
FICA Taxes: FICA stands for “Federal Insurance Contributions Act,” which includes the Social Security and Medicare federal insurance programs. All employers and employees are required to pay into these programs (via taxes). To fulfill the employee tax contribution, employers are required to withhold a certain amount of employee income from each paycheck issued. In addition, employers pay an amount each pay period to account for their portion of the FICA tax.
Self-Employment Taxes (SE tax): SE taxes are the Social Security and Medicare taxes that self-employed individuals are required to pay. Think FICA, but for the self-employed.
Income Taxes: This refers to the tax that federal, state, and local governments impose on individuals and businesses based on their taxable income. Income taxes are billed in addition to FICA and SE taxes.
Tax Bracket: Federal, state, and local governments determine the rate at which taxpayer income can be taxed. Each income range has a tax rate percentage associated with it, acting as a foundation for who’s taxed, and for how much.
Estimated Taxes: Taxes are paid through paycheck withholding or when taxpayers make regular tax payments to the IRS, based on their estimated tax bill (how much they figure they owe, based on relevant tax rates).
What is an Independent Contractor?
An independent contractor is an individual who is hired by a company to perform work — but is not an employee of that company. In other words, the independent contractor is considered “self-employed” and is not on the company’s payroll. Therefore, the company that hires the contractor is not responsible for withholding the contractor’s FICA/SE payroll taxes.
Examples of independent contractors:
- Architect
- Graphic Designer
- Commissioned Artists
- Cleaning Service
- Freelance Photographer
- Office Clerk
Many of these professions can also be hired on as employees — depending on the structure of the business. When accepting a job offer, make sure it’s clear how the employer classifies your position. Whether you’re considered a contractor or employee can have a big impact on your tax rate and how you file your taxes, so, make sure you have this conversation (and a signed agreement) with the client before getting started on any contracted work.
What are my tax obligations as an independent contractor?
As an independent contractor, also known as a self-employed taxpayer, you will generally be required to pay both self-employment tax (SE tax), as well as regular income taxes. SE tax is essentially the FICA tax equivalent for the self-employed, so it’s calculated at a standard rate (15.3%) — more on that a little later.
As for income tax, how much you have to pay depends on where you fall among standard tax brackets. For example, if you’re a single filer making between $38,701 and $82,500, your income tax rate will be 22%.
Independent Contractor Tax Obligations
SE Tax = 15.3%
+
Relative Income Taxes
Who pays SE taxes?
According to the IRS, you must pay self-employment taxes and file Schedule SE if:
- Your net earnings from self-employment exceeded $400 (excluding church employee income)
- You had church employee income of $108.28 or more
When to Pay Taxes as an Independent Contractor
The standard deadline for filing taxes is April 15th, but as a freelancer you may have to pay your taxes on a different schedule than the rest of your fellow taxpayers. Depending on how much you expect to pay in taxes, you might have to pay estimated taxes on a quarterly basis (April 15, June 15, September 15, January 15).
How do I know if I should be paying estimated taxes?
The IRS uses a two-part test to determine whether or not you need to pay estimated taxes. It works as follows:
- You owe $1,000 or more in taxes after subtracting any withholdings and refundable tax credits
- Your tax was more than zero in the previous year
If these two conditions apply, you may need to file and pay estimated taxes. Otherwise, you can file and pay your taxes on the standard April 15th deadline.
What happens if I don’t pay estimated taxes on time?
If you fail to pay your estimated taxes in full or on time, you may incur estimated tax penalties from the IRS. If you are able to prove that your underpayment or failure to pay was due to issues beyond your control, you may be able to avoid penalty or negotiate a lower penalty rate. Missed your estimated tax payment for this quarter? Speak to a tax professional for a free tax consultation today!
How to Pay Independent Contractor Taxes
If you’re paying quarterly…
- Use Form 1040-ES to figure your estimated tax amount based on your income and deductions
- Set up online payments for each quarter, or pay by phone or mail
Note: Accuracy is essential when figuring your estimated taxes—underpayment could result in penalties from the IRS. Consider seeking help from a tax professional to ensure you’re making appropriate payments.
If you’re paying on April 15th…
- Gather all of your 1099 forms and documentation for any deductions you intend to claim
- Choose a filing method—online, with a tax preparer, or by mail
- File your 1099(s)
- Pay your balance by check, direct debit, credit, or cash at an approved retail partner
Independent Contractor Tax FAQs
Now that you know what independent contractor taxes are, and when and how to pay your self-employment taxes, let’s dive into some common questions on the subject.
What’s better — 1099 or W2?
The tax form you get ultimately depends on how your employment is structured, so the question “is a 1099 or a W2 better?” is kind of subjective. If working as an independent contractor makes more sense for you, you’ll be using a 1099 to file; and if you’re employed by a business, you can expect to receive a W2 come tax season. Now, let’s break down the main differences between 1099s and W2s.
Form 1099
The IRS requires businesses who pay contractors $600 or more in a year to issue Form 1099 to any contractor(s) that meet this criteria. That said, if you made $300 total for a side hustle this spring, you might not be 1099’d but you still have to report this amount as self-employment income when you file your taxes.
Each client that pays you more than $600 in a year will have to file and issue their own 1099, so you may have more than one to keep track of, depending on how many clients you’re working with.
What to expect on a 1099:
- Form 1099 will only show the amount the client has paid you in a year
- Form 1099 will not show you payroll taxes you’ve paid (as none have been withheld from your income)
Form W2
Form W2 is the standard tax form for employees—it will show your income and taxes withheld from your paychecks, if you’re hired on as an employee of the company.
What to expect on a W2:
- Your total income earned
- The total amount of federal and state payroll taxes withheld from your paychecks
What’s the current independent contractor tax rate?
According to the IRS the current self-employment payroll tax rate is 15.3%. This rate includes both your contribution in self-employment (SE) taxes as well as your employer’s contribution.
“Hey! I don’t have an employer, that’s why I freelance!” Well you’re not wrong there, but in the IRS’ eyes, you are your own employer. This means that you are responsible for paying 100% of your SE (FICA) taxes.
Social Security Taxes
6.2% (for the employer) + 6.2% (for the employee) = 12.4%
Medicare Taxes
1.45% (for the employer) + 1.45% (for the employee) = 2.9%
Independent Contractor Tax Equation
12.4% + 2.9%
Grand Total: Independent Contractor Taxes
15.3%
Do contractors pay more taxes?
When it comes to payroll taxes, self-employed taxpayers are technically taxed at a higher rate since they’re responsible for both the employee and employer portions of FICA taxes. But as we’ll explore in later in this post, independent contractors do have a number of deductions that they may qualify for with the right documentation—more on that in a moment!
How should I budget for independent contractor taxes?
Budgeting for taxes is not necessarily ideal, but it’s a necessary evil when you’re working freelance. This is because your taxes will not automatically be withheld from your paycheck like an employer would do for classified employees. Drop the ball and forget to plan ahead—and you could end up with a surprising bill when taxes are due. But how much should you set aside for independent contractor taxes?
You can use your previous year’s tax return, in combination with records of how much you’ve already paid in taxes (using the pay-as-you-go/ estimated tax payment system) to help you predict how much you’ll owe in self-employment taxes.
First time freelancer? It is recommended that you set aside about 25-30% of your income to account for your income and self-employment taxes. This can sound like a huge dent to your budget, but keep in mind that you will likely qualify for at least a couple of self-employment deductions.
How do I avoid paying taxes when self-employed?
Unfortunately, you can’t get out of filing your taxes—even if you’re your own boss. But when you’re an independent contractor, you do have the ability to claim deductions that many other taxpayers aren’t entitled to (so long as you meet the IRS’ requirements). These deductions and tax credits can help you save on income taxes and lessen the burden of running your business out of your home, purchasing your own equipment, and funding your own advertising — just to name a few.
Here are some of the most common deductions for independent contractors:
- Home business expenses
- Advertising costs
- Business vehicle expenses
- Supplies
- Equipment repair and maintenance
- Business travel expenses
- Rent or lease payments
Phew! That’s a lot to keep track of — not to mention all of the paperwork, receipts, and effort it takes to claim all of the deductions you qualify for. Rather than getting all mixed up with tax deductions, credits, and all of the other nuances of independent contractor filing, consult a tax professional to help you make sense of ins and outs of the IRS.
What happens if I can’t afford to pay my independent contractor taxes?
It may sound like backwards logic, but if you can’t pay your independent contractor taxes — pay them. Yes, even if you can’t afford to pay your payroll taxes, you still need to pay as much as you can. Failing to pay income and SE taxes could result in serious fines and potential penalties from the IRS. The good news is, the IRS does offer a few different ways to help you approach a hefty tax bill that you might not have been prepared for.
The Fresh Start Initiative, for example, gives taxpayers a chance to set up a payment plan with the IRS in order to pay tax dues at a more manageable rate than a lump sum payment. Fresh Start works like this: once you’re approved, the IRS takes your total tax bill and simply breaks it down into smaller monthly installments, which you will be responsible for until your balance is zero.
Or, if you’re lucky (or have the help of a tax relief service professional), you may be able to get approved for an Offer in Compromise agreement, which means the IRS works with you to negotiate a lower tax bill if your tax debt is insurmountable (among other criteria).
What to Know Before Hiring an Independent Contractor
Now just because employers aren’t responsible for contractor payroll taxes, doesn’t mean they get a free pass on hiring paperwork and processes. If you’re thinking about hiring an independent contractor, you won’t need to set up FICA payroll taxes (which can save you a headache), but you should have the following items documented to protect both parties and remain in compliance with the IRS.
- Form W9: If you expect to pay an independent contractor $600 or more in a year, you won’t be totally absolved of your employment tax responsibilities. You will need to file a W9 for each independent contractor that exceeds $600 in payment in a given year. When tax season comes around, you will then need to issue a 1099 to each contractor that has a W9 on file with your business.
- Application and Resume: Just like you would review an employee’s qualifications and resume before hiring them, you should also take a look at a prospective contractor’s professional experience. If you decide they are indeed the right person for the job, keep a copy of their application and resume on file. Consider taking extra steps to protect your business, like checking the freelancer’s references and conducting a background check on them before signing a contract.
- Written Contract: Before starting any work, you should have a standardized contractor agreement signed by both the contractor and yourself. The contractor agreement should outline your expectations and scope of the work, clearly explain the hiring terms, and detail payment scheduling.
Help Filing Independent Contractor Taxes
Filing and preparing for your independent contractor taxes can be a lot to handle when you’re juggling a handful of clients, projects, and generating new leads to build your portfolio. Our team of tax professionals are ready to take on some of the heavy (tax) lifting.
From help estimating and budgeting for your independent contractor taxes to strategizing for maximum deductions, our enrolled agents and CPAs are here to help every step of the way. Ready to file your independent contractor taxes, minus the number-crunching and painful headaches? Start your free consultation with Community Tax today!
