These days more and more people are working as independent contractors, freelancers, and self-employed business people. Whilst this has many benefits, it also means that you are responsible for many things which you would not normally have to do yourself. For example, you are required to calculate and pay taxes on your income. So tax planning and preparation is a need.
The thought of calculating your own taxes is daunting for most people, but it can be especially difficult for independent contractors as your income may vary week to week, and there may be deductions and other things which you need to take into account. To make it easier, this article is a guide to help independent contractors calculate and file their taxes more easily.
Understand the Business Structure
Business structure for independent contractors can be either a sole proprietorship, limited liability company (LLC), partnership, or S corporation. With any of these structures, contractors’ earnings will be reported as a part of their personal income and so taxes for independent contractors are assessed in the same way. If you work part-time for your own business or as a freelancer, but also an employee of someone else, you will need to file your taxes in two different forms: Form 1040 for your own business taxes and Form W-2 for your employment taxes. The process of calculating taxes for independent contractors and freelancers works the same way, as the IRS only looks at individuals through the lens of their business entity.
Calculate the Taxes
As a self-employed freelancer or entrepreneur, independent contractors need to pay self-employment tax, plus state and federal income tax. These are relatively easy to understand so it is important not to forget either of them when you are arranging your tax returns.
Self-Employment Taxes
Self-employment tax accounts for 15.3 % of an independent contractor’s net income, which includes 12.4% Social Security Tax and 2.9% Medicare Tax. Self-employment tax is filed under Form 1040.
Income Taxes
In addition to self-employment tax, independent contractors still need to pay income tax just like anyone else. Income tax is calculated on the contractor’s total income minus any deductions. The final income tax rate can be consulted in the tax table.
How To Calculate
The Estimated Tax Worksheet, (part of Form 1040-ES), offers a big help for independent contractors who want to calculate their tax themselves.
All the federal taxes above have to be paid four times a year as contractors are obliged by law to pay taxes quarterly, in April, June, September, and January if they earn more than $1,000.
Understand Federal Taxes vs. State and Municipal Taxes
Every state and municipality may also expect independent contractors to pay taxes. As the rate varies geographically, contractors can visit their local tax authorities to find out exactly what they need to pay in addition to their federal taxes. If a contractor works on a freelance basis, their clients will have to file Form 1099-MISC for them, but only if they have paid over $600 that year. If the freelance contractor hires subcontractors to take care of their work, it is up to them to fill out and file the form.
Identify Deductions
It is illegal for independent contractors to skip paying taxes outright; however, there are ways to minimize the money that goes to the IRS. Tax deductions can be reported on Schedule C of Form 1040 where personal income is filed. Depending on each individual contractor, there are various deductions that can be applied. These can be considered for home office repairs or health insurance purposes.
File Your Taxes
Once a contractor has taken all the above the steps, the next thing that needs to be done is the tax filing itself. Depending on finances and how confident they feel, they can either do this themselves or through an accountant.
Taxes can be filed in two ways: by mail or online. To file taxes by mail, independent contractors need to obtain tax forms online, then fill them out and submit them to the IRS. Payment can be made via check or money order. Contractors can also create an account on the IRS website and transfer the money directly from their bank account.
If the business has undergone recent changes, it’s a good idea for independent contractors to consult with a certified accountant for advice. A professional public accountant with years of experience can help minimize the taxes that require payment and simplify the process.
No one wants to think about how much they owe the IRS, but fully understanding the process can make it easier for independent contractors to calculate their taxes. While it is not always necessary for contractors to hire a tax professional, if there is any uncertainty, it is better to get advice than be hit with a penalty. Follow this guide and it will make the process simpler.
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