Independent contractors are people who own their own businesses and rely on that business for income. An independent contractor can also be known as a consultant or freelance worker. People in this industry typically work for many companies or clients in the same field, providing their skill or expertise for a specified period of time. No matter what the title the same tax rules apply to all self-employed individuals.
Paying Taxes
Because independent contractors do not have employers withdrawing money from a pay check and paying taxes directly to the government for them, they are responsible for doing it themselves. This means that they must keep very careful business records and track all income and all taxes owed. It is important to be mindful that taxes need to be paid on earned income so saving a portion of earnings periodically is a good idea.
Quarterly Payments
Tax laws require that, since no money is being paid on behalf of a self-employed business owner each month, that it needs to be paid at least quarterly. This rule only applies if the estimated tax is $1000 or more, which usually applies to anyone with a legitimate business. Independent contractors need to estimate how much income they will make each year and make tax payments accordingly. The IRS can charge a penalty of 6% – 8% on what should have been paid, if the taxes aren’t paid by April 15th. So to avoid penalties, it is important to keep good records and file on time.
Self-Employment Tax
Generally, regular employers pay taxes on an employes behalf, including medicaid and social security taxes. When you are an independent contractor you must pay a self-employment tax of 15.3% of your income. This tax is in addition to any other tax obligations that you might owe. Part of the self-employment tax goes toward medicare at a rate of 2.9%, and the rest of the 12.4% goes toward social security. It’s important for self-employed people to keep this in mind and put aside part of their earnings to be sure to be able to pay the self-employment tax.
Savings
While these tax laws might seem confusing and draining for the independent contractor, there are many tax benefits to owning your own business. If you use an office in your home, you can claim that as a deduction. If you use your vehicle primarily for business you can claim mileage reimbursement. Also, if you are using equipment and utilities for your business, some of those expenses can be written off as well. Any travel and meal expenses that are business related can help as a deduction.
Knowing the tax laws and keeping on top of your tax obligations is very important for an independent contractor. If one is having trouble understanding the taxes related to self-employment, hiring an accountant or financial adviser can be beneficial.