Tuesday, March 26, 2024

How To Pay Taxes As An Independent Contractor

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First Make Sure You Understand Your Business Structure

How to Pay Taxes as an Independent Contractor

Most independent contractors are technically small business owners that operate either as a sole proprietorship, limited liability company , partnership, or S corporation. With any of these business structures, your earnings are reported as part of your personal income for tax purposes.

In the USA, approximately 73% of businesses are registered as sole proprietorshipsâclearly the most popular business structure for entrepreneurs going it on their own. Setting one up is quick and easy: if you donât formally register as a certain type of business entity, the IRS will treat you as a sole proprietor by default.

If you run your business part time, and youâre also someoneâs employee, youâll need to file your own business taxes with Form 1040 . Your employer also files a Form W-2 for you.

Note: taxes work the exact same way for independent contractors and freelancers. As long as youâre self-employed, the IRS only looks at you through the lens of your business entity. So if you understand how your entity type works, youâll know how your taxes work.

Planning Your Quarterly Estimated Taxes

Once you have a total for your estimated taxes, you need a strategy for setting the money aside so youre not surprised each quarter, or worseat tax time. Here are two tried-and-true strategies for managing your quarterly estimated tax payments.

Monthly: Divide your annual estimate by 12 and transfer that amount into a separate tax or savings account each month.

Percentage: Figure out the percentage of your income that will be required, then transfer that percentage of each payment to your tax or savings account. For example, if you will be paying 20% of your income in taxes, youll take 20% of each paycheck and transfer it directly to your tax or savings account.

The strategy that works best for you will depend on the stability of your freelance income and any expenses that offset that income. Play around with the numbers to determine which makes more sense for your situation.

Do I Have To Make Estimated Tax Payments

If youre self-employed you may need to make quarterly estimated tax payments to the IRS, especially if you believe youll owe $1,000 or more when you file. These payments are typically due on April 15, June 15, Sept. 15 and Jan. 15 .

There are two big reasons why its important to pay in during the year, Carlson says. It helps you avoid a situation where you dont have the cash to pay a large bill, and it ensure you dont get hit with an estimated tax penalty.

How much you owe will depend on your expected adjusted gross income, taxable income, taxes, deductions and credits for the year. Since those figures arent always easy to nail down, you can use Form 1040-ES to help you estimate how much to pay.

If youve structured your business as a sole proprietorship, partnership or S corporation, your income from the business may pass through to you as the owner, and youll pay your individual income tax rate on the taxable amount. Thats also the case with some limited liability companies.

If youre planning to make estimated payments, you can do so online through the IRS website, by phone or by mail.

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What Are Estimated Tax Payments

Because you dont have an employer withholding these taxes for you, the IRS wants you to make quarterly estimated tax payments instead of one lump sum. Its an estimated payment because you estimate how much income youll make, and pay taxes based on the estimate.

Youll need to make quarterly tax payments if you meet both these requirements:

  • Youre filing as a sole proprietor, a partnership or a corporation.
  • You expect to owe $1000 or more when you file.

Quarterly payments are due in , , and of the following year.

You can calculate estimated tax payments using Form 1040-ES. It contains a worksheet that can help figure out these taxes. You can also use the vouchers in the 1040-ES booklet to make your payments by mail, or you can pay online.

Similarly, online estimated tax calculators like Turbotax or Bonsai can help you. Accounting software does double duty by calculating the tax and filing returns.

Its important to calculate your payments accurately because you may have to pay a penalty if you dont pay enough throughout the year.

You can avoid penalties if you make quarterly payments of at least 90% of the amount owed for the current tax year. Or you can pay 100% of the taxes you paid the previous year whichever is smaller.

When you file your annual tax return, if youve paid too much, youll get a refund. And if you pay too little, youll owe additional taxes.

Set Up A System To Track Your Income

How to Pay Taxes as an Independent Contractor?

The best way to ensure youre always ready come tax season is to have a system for tracking your inflow.

As an independent contractor, you may want to consider using a freelance time tracking system, such as Clockify.

Clockify is great for these purposes, as it allows you to account for all your work hours with minimal effort.

With Clockify, you can:

Track your work time

Since you dont have an employer to keep track of how much you work, its best to do it yourself and have a record of how many hours you spent on each project and client.

In the Clockify time clock app, you can easily track your time by starting a timer when you begin working on a task.

If you want to take a break, simply pause the timer and resume when you continue working.

If you dont feel like tracking activities in real-time, you can input them manually using Clockifys timesheet view.

Calculate billable hours

Freelancers tend to work less than 30 hours per week, but the truth is not all of that time is spent on billable activities.

Clockify helps you keep track of billable vs. non-billable activities in the following way:

  • Create a time entry for a billable task
  • Set up hourly rates for the task
  • Track time spent on the task by starting the timer whenever you work on the task
  • Let Clockify automatically calculate your billable time

Check out how you can easily track billable hours with Clockify in the video below.

Generate reports

Create invoices

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Estimating An Independent Contractors Federal Tax Liability

Figuring out exactly how much you owe in taxes can be challengingespecially if youre new to working as an independent contractor. Its not as simple as setting aside a specific percentage of your incomesay 25% or 30%because the amount youll ultimately owe depends on your tax bracket and the deductions and tax credits you may be eligible for.

Plus, your estimated taxes need to cover both federal income taxes and self-employment taxes: the independent contractors version of Social Security and Medicare taxes.

How Do You Become An Independent Contractor

You can become an independent contractor by working for yourself. Many freelancers in a gig-centric economy transition are independent contractors who work on a contractual basis to provide goods or services. Independent contractors may have a registered legal business name, earned any necessary certifications or licenses, and pay their estimated taxes quarterly to the IRS.

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Guide To Taxes For Independent Contractors

Working for yourself comes with certain freedoms. As an independent contractor, you can forget the standard 9-to-5 and set your own hours. Rather than earning an annual salary, its up to you to set the price of your workand to sell it. Instead of receiving assignments from a manager, you get to choose who you work with and what type of work you do.

Of course, more freedom comes with more responsibility. If you make more than $400 a year as an independent contractor, managing your business income means managing your taxes, too.

While theres no need to become a tax code expert in addition to running your own business, understanding the basics of the tax system for self-employed individuals can help you make more informed financial decisions. Youll avoid unnecessary penaltiesultimately allowing you to make the most of your professional freedom, while reducing the stress of added responsibilities.

If You Provide Services For One Or More Businesses Or Organizations You Are Considered Either An Employee Or Independent Contractor

How to file your taxes as an independent contractor?

You cannot be both for purposes of a single transaction. In New Mexico, pay received by independent contractors is subject to gross receipts tax unless a statutory exemption or deduction applies to a transaction.

Employee wages are exempt from gross receipts tax. We accept the determination of the Internal Revenue Service regarding your status as an independent contractor or an employee. The IRS offers the following criteria as general guidelines.

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How To Calculate Estimated Tax Payments

The easiest way to calculate estimated taxes is to use the safe harbor rule. The safe harbor rule can protect you from IRS penalties for underpaying your taxes. Typically, underpaying your taxes can result in fines and interest. However, you can avoid penalties if you satisfy the requirements for the safe harbor rule.

The IRS wont penalize you if your payments meet the safe harbor guidelines. Basically, the safe harbor rule protects you as long as your current year estimated payments equal 100% or more of the previous years tax bill. Therefore, you can use the safe harbor rule to determine your estimated tax payments and avoid costly penalties.

To calculate estimated taxes under the safe harbor rule, start by taking 100% of the taxes paid on last years return. Then, divide last years total taxes by four. The resultant total is your quarterly obligation under the safe harbor rule. As long as your payments cover this total, youre protected from penalties. You might owe additional taxes if you made more than you did last year, but the IRS wont knock you for underpayment.

To avoid owing year-end taxes, you can also annualize your estimated 1099 income and deductions. However, accurately forecasting your income for 12 months is difficult. Alternatively, you can also use your businesss quarterly earnings to calculate your estimated tax payments. If you happen to overpay, the IRS will return the excess through a tax refund.

A Guide On How To Pay Independent Contractor Taxes

Whether you work as an independent contractor or self-employed individual in blogging, tutoring, plumbing, or dog walking, you bring a unique set of skills to the world of work. Along with your unique knowledge and expertise, however, comes a distinctive pathway when it comes to navigating tax season and tax year. Unlike traditional employees whose employers withhold employment taxes for things such as Social Security and Medicare, a self-employed individual is required to sort through those numbers, percentages, and paperwork themselves.

Taking charge of your self-employment tax requirements can be a daunting task for even the most skilled professionals. That’s why we’ve put together a guide to simplify the business tax burden process and help you steer clear of any blunders when it comes time to file. Keep reading to learn how you can pay taxes as a contractor like a pro.

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How Are Taxes Calculated For Independent Contractors

To calculate their quarterly taxes, independent contractors must estimate their adjusted gross income, taxable income, taxes, deductions and credits. Its often helpful to use the previous years federal tax return as a guide.

This article is intended to be used as a starting point in analyzing independent contractor taxes and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.

How Does Being An Independent Contract Affect My Pay

How to Pay Tax As an Independent Contractor or Freelancer

You can still get paid for the work you do in your business, but your payments are taken from your business income, not a salary or wages. The money you receive for your work or your products goes into your business checking account. You can take money out of the business , but not as a salary, because you are an ownernot an employee.

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Tip #: Consider Switching Your Business Structure

If youve been in the game for a while and earn a solid income , you may look into becoming an S corporation.

An S corporation is a tax designation for a formal business organization that can reduce your tax liability.

As an S corp with one employee , you can assign yourself a salary and pay your FICA taxes only on that salary, instead of the entire business income.

For example, if your business income equals $120,000 and your salary is $90,000, you dont pay taxes for the remaining $30,000.

However, bear in mind that becoming an S corp can be a complicated process . So, its not advisable unless you are an established one-person business with a steady income stream.

NOTE: If youre thinking about transitioning to S corp, paying yourself a $10 salary, and beating the system its not going to work. The IRS has thought of the loophole, and it requires you to pay yourself a reasonable salary for the type of work you do. This means they have a final say as to what that salary can be, and they wont allow you to make it too low.

What Is Flsa Classification And Where Did It Come From

FLSA stands for Fair Labor Standards Act, and the requirements have actually been around since 1938. The FLSA has gone through some changes since then, but its main purpose is to ensure that employees get paid fairly for their work, whether thats setting the minimum wage at a federal level, or establishing the 40-hour workweek.

The process of FLSA classification is usually concerned with deciding whether you need to pay overtime or not, and thats where well focus our discussion.

If your employees are covered by FLSA, and they are nonexempt, they will be entitled to overtime pay. This is time and a half of their regular pay for every hour they worked over the standard 40-hour working week in a seven-day period.

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Why 1099 Workers Start Paying Taxes At $400

For most people, taxes only kick in if you earn more than the standard deduction. Thatâs about $12,000 if youâre single and $25,000 if youâre married.

So why only $400 for freelancers and contract workers? Itâs because self-employment earnings get taxed differently than other kinds of income.

Canada Pension Plan Payments

Taxes: How much should Independent Contractors pay in estimated taxes

In addition to income tax, you are required to make contributions to the Canada Pension Plan if your income is greater than $3,500 in a given year, even if you are self-employed. The rate for CPP contributions in 2021 is 10.9%, up to an annual maximum of $6,333 .

When making quarterly installment payments you can include an additional amount for CPP contributions based on your annual income, or pay the assessed amount for the year when you complete your tax return.

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How To File Taxes As An Independent Contractor

Independent contractors generally file Schedule C, Profit or Loss from Business with their individual tax returns to report income and expenses to the IRS. An independent contractor who structures their business as a corporation, a partnership or an LLC with more than one member may file a separate business tax return.

How To File Independent Contractor Taxes

Quarterly estimated tax payments can be mailed using the printable vouchers in Form 1040-ES or use IRS Direct Pay to pay online. State and local taxes may not require quarterly filing, and may have their own procedures for payments, so work with a tax professional to be sure youre paying taxes correctly.

If you are working with employers or clients, be sure they are filing a Form 1099-MISC on your behalf. If you hire subcontractors or freelancers to work for you, you need to file a Form 1099-MISC on their behalf. The Form 1099-MISC must be filed with the IRS before February 1st.

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How To Estimate How Much Money To Set Aside For Income Tax

If this is your first year in business, you can approximate how much money you need to set aside by estimating your income and your tax bracket.

  • If you made $400 a week all year, your income before tax would be $20,800the lowest your income would be.
  • If you made $800 a week all year, your income before tax would be $41,600the highest your income would be.

So we can guesstimate that your income would be in this range and use these figures to see approximately how much tax you will pay by using the Canada Revenue Agency’s Canadian income tax rates for individuals. The federal tax rates for 2021 are:

Tax Rate
33.00% $216,511 and over

In your case, both the low and high estimates are still within the 15% tax bracket, so you want try to put aside at least $3,120 , and it would be better if you could put aside $6,240 to cover your potential tax bill.

Now it’s not quite that simple, because this estimate does not take into account provincial and territorial tax rates, which vary depending on what province you’re in, or the fact that presumably you’re going to have various business expenses and income deductions that will lower your net income.

Keep in mind that these are estimates, and any overpayment or underpayment will get sorted out when you complete your tax return at year end, but setting aside these amounts will ensure that you won’t get any unpleasant surprises at tax time.

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