Taxes can be a tricky road to navigate for independent contractors. Employers are required to withhold federal income tax as well as Social Security and Medicare taxes from employee’s payroll checks, but as an independent professional you’re on the hook to do this yourself.
What is an Independent Contractor?
An independent contractor operates as their own independent business—they can have their own business name, perform work for multiple clients, and dictate when, where, and how they work. Independent contractors typically submit invoices for work completed, provide their own tools and equipment, and are responsible for both the individual and employer side of taxes (FICA). They are not entitled to company legal benefits like W-2 employees.
• Operates as an independent business
• May have their own business name
• May perform work for multiple clients
• Submits invoices for work completed
▪ May actively and openly market their services
▪ Provides their own tools and equipment
▪ Works when and where they like
▪ Responsible for both individual and employer side of taxes (FICA)
IRS Schedule C (Form 1040), Profit or Loss From Business, is a standard, required part of a contractor’s annual tax return (unless you are eligible to file Schedule C-EZ), and quarterly estimated tax payments are due four times a year.
Understanding and staying on top of tax payments is important to avoid fines, keep your business finances in order, and make the most of business-related deductions. Follow these four best practices to take the stress out of tax time.
4 Best Practices for Paying Independent Contractor Taxes
1. Always Pay on Time
If you are self-employed and expect to owe $1,000 or more in taxes (or $500 or more for corporations), you’ll need to make quarterly estimated tax payments throughout the year. Paying taxes quarterly helps to eliminate a massive tax burden at the end of the year both for you and for the government.
Quarterly payments are due on April 15, June 15, September 15, and January 15 of each year. In order to calculate quarterly payments, use Form 1040-ES, Estimated Tax for Individuals, which contains blank vouchers you can use to mail in your estimates, or pay online with the Electronic Federal Tax Payment System (EFTPS).
Whether you’re mailing in your vouchers or paying online, set a reminder for at least a week beforehand so your payment arrives on time.
2. Know How Much You Owe
Even for the most seasoned self-employed professionals, knowing how much you owe can be a challenge given the ups and downs of independent work. Essentially, you’re trying to estimate what you’ll make for the year, figure out taxes on that income, and divide it into four payments. If you over-estimate, you’ll likely get a refund. If you underestimate, you’ll owe more money come spring. If you don’t pay at all, or wait to report everything until the end of the year, don’t be surprised to see an audit notification, penalties, or interest payments.
Form 1040-ES walks you through creating a quarterly estimate by looking at your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. If you’re familiar with this process, refer to your previous year’s return to get an idea of what your quarterly payments should be. Estimate paying slightly more than you did last year avoid underpayment. If you’re new to self-employment, consider working with a tax advisor to help calculate what’s best for your situation.
3. Keep Good Records
Understanding how self-employed taxes work, staying organized, and keeping track of your payment history can vastly streamline the tax filing process. For example, if you’re a seasoned independent contractor, being able to refer to your income records for the past few years will make it much easier to estimate your average annual income as well as your taxes owed.
There are also numerous self-employed tax deductions available, so be sure to save receipts and keep detailed records of things like business travel, transportation expenses, and insurance costs to take advantage of deductions for these expenses.
Set aside a little time once a week to categorize receipts, document expenses, and file any tax-related paperwork or documents. Getting in the habit of this process will help to ease the burden of quarterly and annual filing and ensure you don’t overlook deduction opportunities.
4. Manage Your Paperwork
The IRS website’s Self-Employed Tax Center contains a wealth of information about the tax filing process and has links to all the forms you’ll need. In addition to quarterly payments and your Schedule C, you’ll also need to report Social Security and Medicare taxes by filing the Schedule SE (Form 1040) for Self-Employment Tax.
Like any tax preparation, this can all seem overwhelming, but by creating an organized system, maintaining your records, and starting early you can steer clear of penalties and fines. Working with a professional tax preparer or service is recommended to help navigate ever-changing forms, rules, and tax laws, and to identify and claim all of your eligible self-employment deductions.
The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.
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