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Tax Implications of Becoming an Independent Contractor: What You Need to Know

By MBO Partners |

Updated Friday, May 14, 2021

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There are many benefits to choosing to work independently, and more people than ever before are interested in pursuing this line of work. In 2020, 16% of non-independents said they definitely or probably will become independent over the next 2-3 years—a 23% increase from 2019—and 34% said the pandemic made it more likely that they would become independent.

The freedom, flexibility, and control over where and how you work are just a few perks of self-employment. If you’re considering making the switch, it is important to be aware of the tax changes coming your way. With the right preparation and knowledge, you can set yourself and your growing business up for tax success.

Tax Basics for Independent Contractors

If you have ever worked as an employee, you are likely familiar with Form W-2—an employer-provided form that breaks down your wages paid and taxes withheld for the prior year. As an employee, your employer withholds income, Social Security, and Medicare taxes from each of your paychecks. You typically file an income tax return in April and receive a refund or owe money based on your withholding throughout the last year.

As an independent contractor, on the other hand, you will receive Form 1099-MISC from any client who pays you. There is no withholding on this payment. Because you act as both an employer and employee, you are responsible for paying what is referred to as self-employment tax—both the employer and employee side of Social Security and Medicare taxes. The self-employment tax rate is currently 15.3%. You will also need to factor in your income tax. Independents should plan to pay at least 30-35% of their gross income in taxes.

Another key difference when working as an independent contractor is that you pay taxes quarterly rather than once a year. To file, you’ll generally use form 1040-ES, Estimated Tax for Individuals to calculate and pay these taxes. This form contains blank vouchers you can use to mail in payments, or you can make payments online using the Electronic Federal Tax Payment System (EFTPS).

If your business satisfies certain criteria, you can save time, reduce paperwork, and limit issues using the Schedule C-EZ form. You can use this form if you have a profit from your business and:

  • Your expenses are not greater than $5,000,
  • You have no employees,
  • You have no inventory, and
  • You are not using depreciation or deducting the cost of your home.

Self-Employed Tax Advantages

It can take awhile to get used to these tax differences, and consulting a tax professional or accountant is a valuable practice. However, you will quickly come to realize there are many tax benefits to be gained when working independently. Here are a few important ones to be aware of:

1. Retirement contributions

One of the best tax advantages for the self-employed are retirement plans. Tax-deductible qualified plans include:

2. Home office deduction

If you’re self-employed, you’ve probably worked from home in the past. Choosing a dedicated space at home for your office may make you eligible for a home office deduction. There are two ways to take this deduction: the simplified option or the standard option.

The simplified option allows you to deduct $5 per square foot of your home office, for a maximum deduction of $1,500. The standard option may put more money in your pocket but requires keeping more detailed expense records. With the standard option, you can deduct some of your actual home expenses such as mortgage interest or rent, utilities, or homeowner’s insurance.  (rent or interest on your mortgage, internet, phone, utilities, etc).

3. Office equipment and Marketing

You can deduct office equipment related to your business such as your computer or laptop, and supplies like pens, printer ink, paper, and software. The same principal applies to marketing expenses. If you pay to create an ad for your business, buy business cards or stationery as marketing collateral or use a PR firm to promote your business, these costs can be deducted.

When deciding to pursue deductions, it is important to keep records of your business spending and expenses in case of an audit. Save receipts, take pictures, and make sure your listed expenses contain precise, exact figures to avoid raising red flags.

More information on business-related tax deductions can be found on the IRS website.

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.