Independent Contractor Taxes: A Beginner’s Guide
There was a time when you had to explain to those in the 9-to-5 world what it really means to work from the couch or hang out in loungewear all day long; that’s no longer the case.
Since the pandemic pushed so many people into working from home temporarily or permanently, the life of an independent contractor isn’t so difficult to envision now.
To be clear though, being an independent contractor is nothing like working from home when a paycheck still comes regularly and the company is taking out the taxes for you.
How you file taxes is different from what your W2 counterparts do, and that’s the most important administrative thing that sets you apart.
Whether you’re considering making the big leap into the world of freelancing or you’re already in the deep end, your tax situation doesn’t have to be that complicated.
Here’s what you need to know about paying taxes as an independent contractor.
Paying Taxes as an Independent Contractor
Before we get started, we need to stress we’re not tax professionals. This is merely general information and typically applies to sole proprietors or single-member LLCs. For business structures such as an S-Corporation or partnerships, it’s a smart idea to consult a tax professional.
Now that we got that out of the way, let’s go over one of the major differences between being a full-time employee and an independent contractor: quarterly tax payments.
Paying Estimated Quarterly Taxes
Estimated quarterly taxes is what you may give to the IRS estimating how much you’ll need to pay each year. Full-time employees have their taxes taken out with each paycheck, whereas independent contractors don’t
Basically, when you earn money as a freelancer, you name a price, you perform the service and your client pays you — without withholding any money to cover taxes or benefits.
More specifically, you’re getting paid an amount that is pre-tax — the government still wants its cut even if you’re self-employed. As in, it’s your responsibility to make sure you’re paying the correct amount to the IRS.
The amount you pay will depend on how much you need to pay in state taxes (if any) and the amount you’ve earned each quarter. Estimated taxes include both federal income tax — which is organized by tax brackets that run from 10% to 37% — and self-employment tax.
A good rule of thumb: Set aside around 30% to 35% to cover your taxes.
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).
Filing Your Annual April Tax Return
Even though you file and pay quarterly taxes, you’ll still need to file a tax return — the same as someone working at a full-time job. In general, you’ll file a personal tax return, where you’ll indicate your annual income and estimated taxes paid. As you’ve kept up with your quarterly taxes, it shouldn’t be too painful — if you’ve missed payments or neglected the self-employment tax, you may find yourself owing the IRS.
Since you’re the one responsible for keeping track of your income, you’ll want to be diligent about recording every single penny you earn.
Check Your Income Carefully
Every client who pays you more than $600 in a year is required to file a form 1099-NEC in your name, which you’ll receive during tax season. Think of this form as a W-2 except you’re an independent contractor. These forms will list your earned wages but not any withheld taxes — because that’s your responsibility.
You want to make sure that the income you report is the correct amount. If you underreport income, you could owe a penalty and face other serious consequences. That’s why you’ll want to check each 1099-NEC that you get to make sure that the amount stated on the form matches what you have in your records.
Some clients won’t file a 1099-NEC — it’s still your responsibility to report the income earned from these sources.
If You Still Work a Full-Time Job
If you’re currently still at a full-time job and your freelancing is a side hustle, then you’ll still receive a W-2 form. Your employer will send it to you by the end of January for the amount you earned the previous calendar year. A lot of freelancers work part time for someone else in addition to their side hustle for more reliable income and, in some cases, health insurance.
This form displays items such as your earned wages, Social Security contribution, withheld federal income and Medicare taxes. You’ll need to file this form in addition to the amount you’ve earned as an independent contractor.
What Can You Deduct as a Small Business Owner?
As an independent contractor, you’re eligible to make certain business-related deductions as long as they’re considered necessary in the eyes of the IRS. As in, you need those to run your operations. These deductions can lower your overall tax burden — aka the amount you’ll ultimately pay in taxes.
Some of the most common deductions for freelancers include:
- Home office (it needs to be a designated space in your home you use exclusively for business purposes)
- Office supplies
- Travel expenses related to work (like conferences)
- Meals and entertainment, within reason, related to client meetings or business travel
- Professional services, like an accountant
- Half of your self-employment taxes
Should You Hire an Accountant?
However, there are a few times hiring professional help is well worth the money:
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. In this case, calculating quarterly taxes can get a bit hairy, especially true if you’re holding down several gigs to make ends meet.
An accountant can help you work out exactly how much you owe, which can end up saving you money even after you factor in what you pay for their services.
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, in an effort to save on taxes, some independent contractors form an LLC and take the S-corporation option. This business entity is one in which you hire yourself through the business as an employee and pay regular income taxes.
There are other types of business structures like these that are known as a “pass-through” taxation structure. It becomes more complicated because you’ll need to file more paperwork — filing a W-2 as both employee and employer is one of them.
If you go this route, it’s best to hire an accountant to ensure you’re following IRS rules.
3. You don’t want to deal with it (and can afford it).
If you’re earning substantial income and find yourself short on time, it might be well worth the money hiring an accountant to help with filing your quarterly and annual taxes.
Yes, it may be hard to part with the money, but the time you can spend on other tasks can be well worth it. Besides, an accountant may be able to help you save on taxes (such as finding deductions you qualify for you didn’t know about), making their services even more valuable.
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.