Guide to Filing Taxes as an Independent Contractor
New to being an independent contractor? Here’s what you need to know about taxes.
Being an independent contractor or gig worker comes with more flexibility. It also comes with new tax responsibilities.
At a high level, the IRS considers you an independent contractor, and therefore self-employed. You are paid for the result of your work, not for how or when you do it. The “self-employed” status generally translates into higher tax rates and more cumbersome tax filing. But it also generates some potential new tax deductions.
Let’s walk through some things you need to know about taxes as an independent contractor.
You’ll be paying a new tax: self-employment tax
If you’re self-employed, you pay self-employment tax (approximately 15% of your net business income) and federal income tax directly to the IRS. The self-employment tax includes Social Security and Medicare taxes. This generally means that you’ll pay a higher tax rate.
Quarterly estimated tax payments
You probably need to make quarterly tax payments to the IRS. This is especially important if you believe you’ll owe more than $1,000 in income tax when you file. These payments represent an estimate of what you will owe in taxes for a given year based on your projected income and deductions. They are typically due to the IRS on April 15, June 15, September 15, and January 15. These payments can be a big burden for new contractors, as you are now responsible for withholding your own taxes on income and paying them at the appropriate times. It’s important to pay throughout the year so you don’t end up short on cash or with a tax penalty at tax time. The IRS has more information on determining and paying your quarterly estimated tax payments.
New tax forms
You’ll generally receive and use new tax forms. As an independent contractor, you need to file your own business taxes on Form 1040 (the standard tax return). You’ll use a Schedule C to report income and expenses and a Schedule SE to determine your self-employment tax. You may need to fill out new state and local tax forms as well.
Whenever you receive $400 or more of income, you should receive a Form 1099 (instead of a W-2 for employees) at tax time that you must report when filing your income taxes. However, you may not always receive official tax forms to track your income. You are still liable to report all of your income, so you’ll need to keep your own records. See the IRS’s Tax Guide for Small Business for more information on federal tax laws and the self-employed.
Tracking your income and documenting your expenses
Being self-employed requires a lot of organization and documentation. You need to set up financial systems for tracking your income, documenting your expenses, regularly setting aside money for taxes, and paying your estimated tax bills on time.
You may start with a simple Excel spreadsheet for tracking your business finances. If it’s getting too complicated, consider budgeting software like QuickBooks or Quicken or expense trackers like Expensify or Stride. Carefully track your expenses to maximize your eligible tax deduction and minimize your tax liability.
From the start, establish a separate savings account for your taxes. Set aside at least 20% of your income in that account to be able to pay your taxes on time and in full.
You may be able to get some new tax breaks from business-related deductions to reduce your federal income tax obligation. Along with the new tax responsibilities of being an independent contractor come a few tax benefits. Namely, expenses that might otherwise be considered “personal” can be deducted as business expenses. These include services, items, or amenities you use for business purposes. Some common examples are phone and internet, office supplies, use of your personal vehicle, a portion of rent, certain meals, and health insurance.
Business deductions effectively reduce your business’s taxable income and could lower how much you owe in federal income tax. But deductions have their limits. To understand the rules of deducting business expenses, see this guide from the IRS.
Is an accountant right for you?
You may want to hire an accountant to protect yourself. A certified public accountant will understand how federal taxes work. They can help you manage your new responsibilities, avoid costly mistakes and tax problems, take advantage of available deductions, make filing your taxes easier, decrease your overall tax liability, and safeguard the health and longevity of your business. While an accountant is an extra cost, it can also provide peace of mind and might be a worthwhile expense.
Saving for retirement
When you are feeling established as an independent contractor, consider starting a retirement account. Self-employed people have some unique options when it comes to retirement savings that aren’t available to employees. A SEP-IRA is one option. It allows self-employed people to set aside significantly more than in other accounts, providing you with deductions on your tax return while building your retirement savings. It’s wise to consult a financial planning professional before making investment decisions. I would recommend a fee-only advisor (who is compensated directly by you for advice).
More resources for independent contractors
Christi Baker is a nationally recognized financial educator and coach who has 25 years of experience building financial health with individuals and through community-based organizations. She believes in allowing personal values and vision to the lead the journey to financial health alongside the right tools, support, and resources.