Filing your own taxes can be a huge headache, especially if you’re an independent contractor. Failing to report your earnings properly can bring serious and long-lasting repercussions to your professional and personal life. So if you’re wondering how to file taxes as an independent contractor, keep on reading. Here’s a guide to help you avoid common pitfalls and navigate this year’s tax season successfully.
Who is classified as an independent contractor?
The IRS considers any self-employed individual as an independent contractor. As a basic rule of thumb, everybody who offers their services to the general public falls under this category – from doctors, accountants, landscapers, and tutors to lawyers, hair stylists, and writers. You can determine your status and find out if you are, indeed, self-employed (or employee) by visiting this IRS page. You may also fill out Form SS-8 and have the IRS determine your status for you. In the latter case, note that it may take up to six months to get a determination.
Taxes you need to pay as an independent contractor
Remember that independent contractors are called to pay more federal taxes than employees receiving a W-2. Having that said, here is a list of these taxes.
Self-employment tax (SE tax)
It covers Medicare and Social Security costs at a current rate of 15.3%, with 2.9% going to Medicare and 12.4% going to Social Security costs. You can pay this tax in quarterly estimated tax payments throughout the fiscal year.
Your business earnings will pinpoint whether you are on the hook for the SE tax or not. If your net earnings (subtract your business expenses from its income to figure it out) are over $400, you need to file an income tax return. If not, check the filing requirements listed on Form 1040 and 1040-SR to see if you still need to file a return or not. To pay your income tax and the SE tax, you will need to fill your tax return and IRS Schedule C or C-EZ.
Social Security & Medicare
To report these taxes, you must file Schedule SE, which calculates how much you owe from Social Security and Medicare taxes by using your loss and income figures as reported on the Schedule C form.
State & municipal taxes
There is no one-size-fits-all tax, in this case, as every state and local tax authority has its own withholding policies. Some states require independent contractors to pay a flat rate, while others rely on the earned income and apply various rates. You can visit the State & Local Government platform to access your state’s Department of Revenue.
Tax deductions and expenses to include in your filling
Ensuring that you file deductions correctly will help save money in the long run and lower your overall tax burden. Some deductible expenses are travel-related. So if you travel regularly, you can deduct things like tolls, parking, and mileage at a specific rate.
Other deductible costs are the money you spend on (1) meals and entertainment (some exceptions apply), (2) cell phone, (3) interest, (4) rent, (5) materials, (6) supplies, and (7) web hosting (and other occupational operating costs), as well as (8) health insurance, (9) self-employment, and (10) construction industry taxes. There is even a pass-through tax deduction called the Qualified Business Income Deduction that allows you to deduct up to 20% of your qualified business income, per the Tax Cut and Jobs Act.
However, the nature of your individual business will determine what you can eventually deduct or not as some of these deductions come with certain limitations. Your business will also determine whether you qualify for some business credits available at this given moment.
Making quarterly payments
Most of the time, small business self-employed individuals are required to file their taxes quarterly the same way one would if their income came from a sole proprietorship, pass-through entity, or rental property. When you’re working as an employee, your employer is responsible for withholding your taxes for you. Being an independent contractor, however, means that you are on your own in this regard.
When should you plan to pay taxes on a quarterly basis? According to the IRS, if you expect to owe at least $1,000 in federal taxes at the time you file your tax return. You can calculate your estimated tax liability by using Form 1040-ES. Your anticipated tax income, gross income, each tax credit and deduction for the year, and your taxes will determine how much money you will owe the IRS. If you underestimate or overestimate the number you give, you can recalculate your estimated taxes for the following quarter by using Form 1040-ES. Finally, you can pay your estimated quarterly payments either by mail or phone on the IRS website.
For the 2020 tax year, the due dates per quarterly payment are (1) April 15, (2) June 15, (3) September 15, and (4) January 15, 2021. Nevertheless, the IRS may change these dates at its own discretion.
Tip: If your income comes exclusively from your independent contracting, you can (roughly) figure out your state and tax liability. You simply look into the deductions you have and what your revenues will probably be for the year. This way, you can save some money for when you will be called to pay taxes (and avoid having to deal with a huge tax bill at the end of the year).
Best practices for self-employment taxes
Good record-keeping is an often overlooked practice, yet it can make things so much easier when it comes to tax preps. Properly documenting your business losses and earnings will help you estimate your quarterly tax liability, providing that you also substantiate all of your business expenses the right way. Another good idea to help track what is a business expense and what is not is to open a secondary checking account for your business (as a DBA or in the business’ name).
Needless to say, try to avoid waiting until the last minute to deal with your tax requirements. Instead, prefer handing them throughout the year so you can mitigate income tax at the end of the year by taking advantage of deductions.
Truth be told, in the majority of cases, independent contractors find it difficult to file their own taxes due to the confusing language the IRS uses on its documents and publications. So it’s no shame to ask the assistance of a tax professional to work on your taxes so you can make the most out of your tax return.
This page is for informational purposes only. Chime does not provide financial, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for financial, legal or accounting advice. You should consult your own financial, legal and accounting advisors before engaging in any transaction.