Becoming an independent contractor is an exciting and liberating career move. And while it can mean greater pay and flexibility, it also often requires that you complete tasks that your former employers may have done for you.
For instance, independent contractors cannot automatically pay taxes throughout the year. When employed by someone else, the employer completes this task on behalf of the employees by deducting an appropriate amount from each paycheck. Therefore, tax planning is vital to being an independent contractor since you must ensure these payments are made. Inadequate planning can leave you with a huge tax bill at the end of the year.
This article provides basic information about taxes and tax planning for independent contractors.
Who is considered an independent contractor?
There have been changes to who may be considered an independent contractor in recent years. They state that an independent contractor is a business or individual that performs services for other businesses. Therefore, knowing how the IRS defines an independent contractor is vital. The contractor must also meet the following conditions:
- The contractor has sole responsibility for deciding where, how, and when they work.
- The hiring business only controls the work’s results, not the method of its completion.
- The hiring business pays for a service only, not health insurance, social security contributions, or other benefits.
- The contractor works independently, beyond any management or authority of the business.
Independent contractors can also be structured as a sole proprietorship, a limited liability company (LLC), or an S-corporation.
How do independent contractors pay taxes?
Unlike employees who have taxes withheld from every paycheck, independent contractors must withhold their own taxes. Because independent contractors do not have anyone to pay taxes on their behalf, they must keep accurate records. Many independent contractors then pay their taxes quarterly, including Social Security and Medicare. The quarterly tax estimates can be placed on the 1040-ES, Estimated Tax for Individuals.
Therefore, the four main differences between filing taxes as an employee and as an independent contractor are:
- Self-employment income and deductions are reported on Schedule C.
- Self-employment taxes are found on Schedule SE.
- Quarterly tax payments must be estimated and made.
- Independent contractors will receive a form 1099-MISC from hiring companies rather than a W-2.
When do independent contractors need to pay taxes?
Independent contractors expecting to earn more than $1,000 or more in tax liability will have to pay quarterly tax estimates, which must be completed by the due date. A failure to pay them by the due dates likely means they will face penalties when they file taxes at the end of the year.
The deadlines for quarterly tax payments are:
- April 15: Tax payments are required for all income earned between January 1st and March 31st.
- June 15: Tax payments are required for all income earned between April 1st and May 31st.
- September 15: Tax payments are required for all income earned between June 1st and August 31st.
- January 15: Tax payments are required for all income earned between September 1st and December 31st.
What happens if I miss a quarterly payment?
If, for some reason, you are unable to make a quarterly payment or are intentionally not paying it, the IRS will charge a 0.5% penalty for each month – or partial month – that you have not paid, with a maximum of 25% charged. Additionally, they will charge interest on owed money.
If you cannot make the payment, you may also submit an IRS form 2210 to waive the fee, but you will have to explain why you cannot make a payment and include any supporting documentation. For example, the IRS may reduce the penalty if you are a victim of a disaster or casualty or your missed payment was due to reasonable cause rather than willful neglect.
Do I have to make quarterly payments if I just have a ‘side gig’?
It’s becoming more common for people to supplement their primary income from a full-time job with a ‘side gig.’ While this is technically considered work as an independent contractor, these individuals may avoid paying quarterly payments. However, it is a good idea to adjust your W-4 with your employer so that you withhold additional taxes to cover your tax liability for the year. Failure to do this can leave you with a big tax bill when you file your income taxes.
Taxes and tax planning can be complex for independent contractors. Therefore, many of these professionals may benefit from working with a tax planner or CPA. To learn more about tax planning for independent contractors, contact Parker Business Consulting today!
Parker Business Consulting & Accounting, P.C. is a unique firm with more than a combined 75 years of experience in private industry, coupled with a strong background in public accounting. This combination enables us to provide valuable assistance based on direct experience with many of our clients’ same issues.