Key Takeaways
1. Independent contractors file as sole proprietors, but they can also own an LLC (limited liability company).
2. An independent contractor in the US is different from being an employee. An independent contractor is not on salary for a company but might be a small business owner, an artist, designer, or computer expert, for example. These contractors work for other people as non-employees.
3. If your income as an independent contractor exceeds $200,000, you are also taxed an additional surtax for Medicare amounting to 0.9%.
4. Independent contractor taxes also include federal income tax. There are seven US tax brackets which range from 10% to 37%. The more you earn, the more you pay.
5. Depending on your state, you may be required to pay state or municipality taxes. However, several states, such as Texas, Florida, Washington, and Nevada, don’t charge personal income tax.
Independent contractor taxes work differently than employee taxes: Perhaps the biggest difference is that it is the responsibility of the independent contractor to pay their own income tax, whereas employers must withhold this for their employees.
In this guide to independent contractor taxes, we set out the key matters that both the independent contractor and their client should be aware of when managing independent contractor taxes.
Quarterly Payments for Independent Contractor Taxes
As mentioned, a core feature of independent contractor taxes is that the independent contractor has responsibility for paying their own taxes. But this doesn’t mean that they pay it all at the end of the tax year.
In the United States, you must make quarterly tax payments if, as a contractor, you will owe more than $1,000 in taxes for the tax year. You can estimate your tax using IRS Form 1040-ES.
For more information, see the helpful video on estimated tax payments produced by the Internal Revenue Service (IRS) below.
If you are a foreign independent contractor working in the US and your country has a tax treaty with the US, you need to fill out IRS Form 8233. It is the Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services as a Nonresident Alien Individual.
If there isn’t a tax treaty between the US and your country, your employer will withhold the total income tax for non-residents, which is 30%.
Independent contractors are sometimes called 1099 employees.
In the wake of the COVID-19 global pandemic, more and more businesses and employees are opting for a less formal working relationship that offers flexibility. With the rise of freelance work, there has also been growing confusion surrounding ‘1099 employees’ (a popular name for independent contractors), the benefits, and the tax implications of hiring them.
Indeed, 1099 employees/freelancers / independent contractors are treated differently than traditional W-2 employees for tax purposes.
What taxes must independent contractors pay?
Independent contractors must pay a self-employment tax, which is a version of the FICA, which companies usually pay for employees. It is made up of Social Security and Medicare contributions.
The self-employment tax rate is 15.3%. You can claim the employers’ portion (7.65%) as a deduction when you file your return. Contractors can claim it on line 14 of Schedule 1 in IRS Form 1040.
Independent contractors must also pay a federal income tax. There are seven tax brackets ranging from 10% to 37%. The more you earn, the more you pay.
Depending on your state, an independent contractor must also pay state and municipal taxes. Several states don’t charge personal income tax, such as Texas, Florida, Washington, and Nevada.
There are other taxes that independent contractors have to pay in some countries, such as VAT. A value-added tax (VAT) is an indirect tax on goods and services (hence why it is known as ‘GST’ in some countries). It is levied on the price of a product or service at each stage of production, distribution, or sale to the end consumer.
VAT is usually implemented as a location-based tax, where the tax rate is based on the consumer’s location and applied to the sales price. For example, if you work in Hong Kong and go shopping in London, you must pay a VAT tax before leaving the UK on goods you purchased there.
What business expenses can independent contractors deduct?
An independent contractor can deduct many business expenses, which will lower the amount of your taxable income and thus reduce your tax bill.
Deductions are reported on Schedule C of IRS Form 1040. They include:
1. Home office expenses
Since many independent contractors work from home rather than going into the company’s offices, you can write off a portion of your rent, mortgage, or property taxes. You can do so if your home office is a dedicated space used exclusively for work. Second, the home office must be your primary place for doing business.
You can calculate your home office deduction by determining the percentage of your home area occupied by your office.
The IRS makes a simplified deduction for home offices under 300 square feet – $5 per square foot, or $1500 per year.
2. Health insurance
If you pay out of pocket, an independent contractor can deduct health care and dental insurance for yourself, your spouse, and children under 27.
3. Car expenses
All business expenses related to the car are tax-deductible, including mileage, tolls, and parking. Keep track of your mileage and gas purchases when visiting clients or handling other business matters, so that you can deduct these costs.
Among the other business expenses that can be deducted are:
- Bank fees
- Equipment depreciation
- Cell phone and internet expenses
- Education related to self-employment.
What do businesses need to do to comply with independent contractor taxes?
Employers who hire independent contractors must fill out several tax forms.
In the US, these include:
- IRS Form W-9. The W-9 or Request for Taxpayer Identification Number and Certification is used by companies or clients working with US-based independent contractors. The employer should provide this form to the contractor at the beginning of the working relationship. It is a way for the employer to collect the contractor’s name, address, and Social Security number or Tax ID number. It is not submitted to the IRS.
- W-8 BEN. If you are a contractor located outside the US and your client is an American company, the contractor will provide the employer with a filled-out IRS W-8 BEN form. This will ensure accurate tax withholding.
- 1099-NEC. As a contractor, you will receive IRS Form 1099-NEC from every client who paid more than $600 to you during a year. The IRS requests employers send the 1099-NEC to every independent contractor by January 31. The form indicates the amount paid to the contractor during the previous year.
Horizons supports independent contractor hire
Many employers prefer to outsource their hiring of independent contractors to a Contract Management Outsourcing firm like Horizons, especially in cases of international expansion. Horizons knows that it is crucial to apply different rules for contractors than the rules that are used for employees on the payroll. This ensures compliance with tax and business regulations.
Horizons can obtain the necessary forms for independent contractors’ taxation, review the independent contractor agreement, and establish a suitable payment method. Contact Horizons today to learn more.
Frequently Asked Questions
In the United States, independent contractors must pay:
- Self-employment tax of 15,3%
- Income tax – rates range from 10% to 37%
- State and municipal taxes – depending on where you live
- VAT/GST for goods purchased overseas.
Independent contractors in the US need to pay their taxes by the following dates:
- April 15
- June 15
- September 15
- January 15
