Independent Contractor Taxes: A Beginner’s Guide
Freelancing certainly has its perks. Filing taxes is not one of them.
Whether you’re considering making the leap into the world of freelancing or you’re already in the deep end, independent contractor taxes don’t have to be that complicated.
Here’s what you need to know to keep Uncle Sam happy as you navigate your entrepreneurial venture.
How Do You Pay Taxes as an Independent Contractor?
The advice below will vary if you’ve chosen a business structure like an S-Corp or an LLC. Since sole proprietorships are the default for most freelancers, we’ll focus on what those taxes look like.
First thing’s first: making quarterly payments.
Estimated Quarterly Taxes: How Much Do You Need to Set Aside?
When you earn money as a freelancer, the transaction is direct: You name a price, you perform the service and your client pays you. The client doesn’t withhold any money to cover taxes or benefits like they would for their employees.
Of course, the government still wants its cut even if you’re self-employed — which means it’s your responsibility to dole out that portion. A good rule of thumb: Set aside about 30-35% of every paycheck you make to cover your federal taxes as an independent contractor.
This will include both federal income tax — which is organized by brackets and will likely run between 10-37%, unless you’re doing exceptionally well — and self-employment tax, an additional tax levied on independent contractors currently totalling 15.3%.
Instead of having these taxes withheld from each paycheck, you’ll pay them off on a quarterly basis using Form 1040-ES. Quarterly tax payments are due in January, April, June and September, and they’re super easy to file online through a bank transfer. However, you can also pay by phone or snail mail; the address will vary depending on your location.
Keep in mind that the 30-35% you set aside may not cover state or local taxes, which vary depending on your location. For example, along with its regular state income tax, New Mexico charges small business owners a gross receipts tax for “the privilege of doing business” here — which ranges from 5.125% to 9.4375% (though changes in these rates can change throughout the year) depending on your county.
When Are Quarterly Taxes Due?
Quarterly taxes are due around the same time each calendar year and is based on the amount you’ve earned for each quarter:
- Jan. 15: For Sept. 1-Dec. 31 of the previous year
- April 15: For income earned from Jan. 1-March 31
- June 15: For income earned from April 1-May 31
- Sept. 15: For June 1-Aug. 31
To pay these taxes, you’ll file Form 1040-ES with the IRS on or before the due date. You can file and pay your quarterly taxes online (generally the easiest option), by phone or mailing in your payment. If you need to pay state taxes, it’s best to check how much you’ll need to owe and where exactly to send it off (if it’s not through the IRS, that is).
More on Self-Employment Tax
Although often decried among freelancers as punitive, self-employment tax is designed to cover independent contractors’ contributions to Social Security and Medicare.
As you may have noticed on your paystubs, the percentage withheld for these programs is only 7.65% when you work a traditional job. That’s because employers pay the other half.
Since you’re technically the employer, independent contractors — so long as they earn more than $400 in freelance income — are required to pay the full 15.3% to cover their full contribution.
Yes, freelancers, you actually do pay more because you don’t have an employer splitting the bill with you.
The good news is, this percentage is levied against your net income. Meaning,you calculate your independent contractor taxes after you take out your eligible deductible expenses. (More on that in a minute!)
The Dreaded April Tax Return
You will need to file a tax return if you’ve made at least $400 in net income from your freelancing in a calendar year. So long as you’ve kept up with your quarterly taxes, filing taxes could mean you’re not caught off guard. l However, if you’ve missed payments or paid less (like forgoing the self-employment tax), you may find yourself owing the IRS and any penalties it may impose.
Your April tax return should report the sum of your earnings, used to calculate your tax bracket and total tax burden. For freelancers, this means you’ll need to be diligent about recording every single penny you earn.
Calculating Your Total Income
Each client who pays you more than $600 in a year’s time must file a form 1099-MISC or 1099-NEC in your name, which you’ll receive around tax season in place of a W-2. It should list your earned wages but not any withheld taxes — because, again, as an independent contractor, that’s your responsibility.
When you receive any of these forms, check to make sure all the information is accurate, especially the income amount. If not, contact your client and ask them to correct it.
Although it’s tempting to under-report your income in an effort to pay less in taxes, don’t. You could face some serious consequences like hefty penalties. And seriously, do you really want to go through the hassle of an audit? Save yourself time and money in the long term and just cough up what you owe.
Even if you earn less than $600 from a client, that income still counts toward your annual total, which means you need to include it on your return.
Do You Still Get a W-2?
Not all freelancers run their own business full time. Some may do it as a side hustle part-time in addition to their part- or full-time job.
If that’s you, your employer will still need to file a W-2 for you. You’ll receive it sometime in February each year, and you’ll need your W-2 to file your return. It displays information such as your earned wages, Social Security contribution, withheld federal income, and Medicare taxes.
If filing independent contractor taxes as someone who works part- or full-time feels daunting, it may be a good idea to hire a tax professional.
What Can You Deduct as a Small Business Owner?
As a small business owner, you’re eligible to make certain business-related deductions, which can lower the overall amount you pay in taxes and help keep your business more cost-effective to run.
The IRS language on deductions is pretty open-ended: “To be deductible, a business expense must be both ordinary and necessary.” So you can make an argument for deducting an array of costs.
Some of the most common deductions for freelancers include the cost of your home office, office supplies and travel expenses related to work. But you can also deduct meals and entertainment — within reason — that are related to client meetings, as well as professional services, like those of an accountant.
Should You Hire an Accountant?
The internet has made filing taxes a whole lot easier. Freelancers can take advantage of the sophisticated software from companies like TurboTax or H&R Block, which are both low-cost and straightforward to use.
But in some cases, hiring professional help is well worth the money, such as in the following scenarios.
1. You have a W-2 job (or three) alongside your freelance business.
Working a traditional job means you’ve already contributed some of what you owe for Social Security and Medicare and can complicate your self-employment tax return substantially.
An accountant can help you work out exactly how much you owe. Hiring a professional can end up saving you money, even after factoring in their charges.
2. You’ve elected a more convoluted business structure.
While most freelancers operate as sole proprietorships, there can be benefits to incorporating a growing freelance business. For instance, by moving to an LLC and taking the S-corporation option, you could avoid paying self-employment tax on a significant portion of your income.
Overall it’s a complicated — though perfectly legal — method in which you hire yourself through the business as an employee and pay regular income taxes. It’s known as a “pass-through” taxation structure, and among other paperwork requirements, it means you’ll file a W-2 as both employee and employer.
And there’s even more such paperwork at tax time. A good accountant can make sure you have all your T’s crossed and I’s dotted — and when it comes to the IRS, you want to be as accurate as possible.
3. You just don’t want to deal with it.
Many accountants charge a few hundred dollars to make Uncle Sam happy. This is money well spent. For freelancers. For everyone.
Although independent contractor taxes are significantly more complex than for those who work a traditional job, it’s hard to compete with the freedom and flexibility of the freelance lifestyle.
In many cases, the CPA fees are totally worth it.
Frequently Asked Questions (FAQs) About Independent Contractor Taxes
We answer the most common questions about how to pay taxes as an independent contractor.
You’ll need to pay estimated taxes each quarter in addition to filing an annual tax return. To pay quarterly taxes, you’ll need to calculate the amount you owe (it’s based on your income for the quarter). The IRS allows you to pay online, by phone, or via snail mail.
A good rule of thumb is to set aside around 30% to 35% of the amount you earn for taxes. This may seem high — especially if you are usually in a lower tax bracket — but it will give you a cushion. Knowing that you have to withhold this percentage for taxes might push you to set higher rates, too.
You can work to minimize the amount you pay in taxes by claiming business expenses on your tax return. These expenses need to be considered essential to running your business.
Contributor Sarah Li-Cain is a personal finance writer based in Jacksonville, Florida, specializing in real estate, insurance, banking, loans and credit. She is the host of the Buzzsprout and Beyond the Dollar podcasts. Penny Hoarder contributor Jamie Cattanach’s work has been featured at Fodor’s, Yahoo, SELF, The Huffington Post, The Motley Fool, Roads & Kingdoms and other outlets.