Taxes are mandatory in life. Every working person pays taxes. Humans pay different types of taxes. Taxpayers in some countries are heavily burdened with the amount of money they pay as taxes. In other countries, the tax burden seems equally shared and not as strenuous as in other nations. The law does not exempt independent contractors from paying taxes either. Paying taxes is a way of fulfilling your social responsibility to your country. Independent contractor taxes go a long way to helping the government meet its objectives.
The objective of this article is to help you understand the taxes independent contractors pay.
Furthermore, you will learn about the documents that the contractors fill when filing taxes.
Independent contractors, just like everybody else, do not enjoy paying taxes. One of the reasons for this is nobody enjoys losing money. Paying taxes means taking more money from whatever little you have and giving it to the government. Additionally, those who hate paying taxes cite the fact they do not understand issues regarding taxation well. In addition to that, they also cite the fact it’s the government, which they hate, that collects the taxes. Regardless of the hatred the contractors feel towards taxes, they have no choice than to pay their dues.
Independent contractors pay different types of taxes as you will see below.
First, it is good to understand the factors that qualify you as an independent contractor. To file, submit and report any taxes as an independent contractor, you have to be a person who is in charge of your time. You have to be a professional who sets your own working hours. Nobody determines when you report to work or leave. Furthermore, you qualify as an independent contractor if you control the kind of relationship you have with your clients. Other factors that give you 100% eligibility as an independent contractor include:
Once you confirm your status as a bona fide independent contractor, the next task is to look at the kind of taxes you have to pay. The first is the Social Security taxes. Normally, the employed people would share the burden of paying Social Security taxes with their employers. Independent contractors have no one to share this burden with. Instead, they carry the entire burden on their shoulders. They pay every dime they owe.
It is good for independent contractors to pay their Social Security taxes on time. The law stipulates that all employees have to pay 6.2 percent of their income as Social Security tax. The law requires employers to match this rate by contributing 6.2% for each worker too. On the other hand, self-employed individuals (including independent contractors) should pay 12.4 percent of the income they earn each year as Social Security tax. Read here to learn more about Social Security tax.
Next, independent contractors have to look at the various 1099 tax forms. In fact, the contractors cannot be up to date with the independent contractor tax if they do nothing about these forms. There are different types of 1099 forms. The forms are crucial when filing your taxes. They provide details of the money you earned as income from each client with whom you worked or extended freelance services to over the past year. The clients should send you these forms by January 31 each year. Contact them if they fail to send the forms on schedule.
You need as many documents as possible to prove that you earned or spent what you have indicated on the independent contractor tax forms. Look for the receipts and invoices. These documents will help you when filing for tax deductions. Without them, you may have to pay the entire amount you owe as taxes, or more. You need proof for every claim for a deduction you make while filing your taxes. Therefore, never discard documents such as receipts for supplies, invoices, health insurance premiums, home office rent, utilities, and business expenses.
Keep 1099 forms separate from W-2 forms. The former are for independent contractors. The latter apply when you also work as a salaried employee for somebody else. It is crucial that you learn to fill the two types of forms separately. The W-2 form shows that you work for somebody and that your taxes have already been deducted from your salaries. The 1099 forms show that you earned some extra money as a freelancer or independent contractor. All the income on your W-2 should also be reported on 1040 forms rather than 1099.
The next task is to calculate the difference between your expenses and income. Ideally, your expenses will be lower than the income. Where the difference shows a profit of $400 or more, you will have to pay self-employment or independent contractor tax. At times, some contractors feel tempted not to report any income that failed to generate a profit of more than $400. However, doing so could come back to haunt you. Instead, make it a habit to report all incomes, especially anything that already appears on the 1099 forms.
Otherwise, you will be setting yourself up for a bit of confrontation with the IRS.
Spend some time researching on all the deductions that are due to you. The IRS allows you to deduct specific amounts from the taxable income you earn as a freelancer. Check Part II of Schedule C, which you will find in IRS Publication 535, to confirm the types of deductions you are entitled to make or claim. Most deductions are percentages of the costs you incurred when buying something related to the freelance services you provide. For example, you can deduct the money you spent buying office supplies from the taxable income.
Other deductions you are entitled to make include:
It is good to show there is a door that separates your home office from all the other rooms.
The deductions you are entitled to are capable of reducing your tax liability greatly. You cannot make deductions unless you can prove that what you wish to deduct is actually a business expense. Personal expenses do not apply here. You can only make deductions for legitimate expenses. It is upon you to prove that you spent the money on what you claim. Otherwise, the IRS may send you a stern letter asking for proof. Failure to provide the proof could lead to heavy penalties, which could leave a huge dent on your business finances.
Document the expenses clearly by indicating the following:
Independent contractor taxes also involve income tax. Where income taxes are applicable, you have to focus on determining the net income first. The net income should be from all business activities you engaged in over the past year. Any person who runs a business – or works as an independent contractor – is interested in making money. You do not run a business as a charitable or not-for-profit organization. As you make money for the business, you will have to learn to what earnings, profits, and net income.
Net income is critical for various reasons. One, it helps in determining self-employment tax that self-employed owners of businesses should pay. Two, it is crucial in determining the tax corporations should pay. Three, it is helpful in determining the tax sole proprietor businesses should file as business taxes under Schedule C. In addition to all that, net income also helps in determining the tax that all LLC members, individual partners, and corporation owners should pay. Therefore, do not handle matters regarding your net income lightly.
In business circles, the three terms mean the same thing. You can use one term for the other and not cause any confusion. Net income simply refers to the amount that stands as the difference between your business’ gross incomes and all the expenses incurred. The expenses include taxes, interests, and depreciation. The net amount includes the revenue the business earned and deductions you made to that income. When income covers and then exceeds your expenses, you will have made profits.
However, there are times when the business does not earn enough to cover all its expenses. In such instances, you will report negative earnings, a loss, or net loss. Net loss is the opposite of net income. The net income will always appear under the Profit and Loss Sheet. The sheet provides a summary of all the expenses and costs you incurred as well as the revenues the business earned over the course of the year. You will need this document (or sheet) too to file your income tax. Find a few profit and loss statement templates here.
While filing your income tax, you need to take notice of Schedule C.
Schedule C is where you calculate all the taxes you have to pay to avoid annoying IRS.
Filling Schedule C can appear a bit daunting, especially if you have never done it before. The first thing you have to do is to enter the total gross income you earned as a freelancer. Enter this income in Part I of Schedule C. Next, enteral the expenses you incurred in Part II. Afterward, enter details regarding the cost of the freelancing services you offered in Part III. Do you have a business car? If you do, enter all information regarding it in Part IV, as this will come in handy when you make claims for tax deductions.
Details regarding any other expense you may have should appear in Part V. Under Part V, you are free to enter miscellaneous expenses such as (but not limited to) business start-up costs, bad debts, or any amount of money you spent to make your home office more energy efficient. Thereafter, take your time to calculate the total income or loss (depending on what you made the last year). Once you are through with the calculation, enter the information (the amount you arrived at) on Line 12 of the 1040 Form in your possession.
As you learn about independent contractor taxes, it is important that you avoid making the mistake of ignoring Self-Employment Tax. Always account for this tax. Income tax is not the only type of independent contractor taxes you will pay when working as a self-employed individual. Payroll taxes are also applicable since they cover your Medicare and Social Security. Make an effort to find out how much you owe as self-employment tax. Make sure the amount appears in all the appropriate documentation.
Assuming that you have prepared and calculated all the independent contractor taxes, the next task is to actually pay. Filing or reporting the taxes is not the be-all and end-all. No, you still need to send the amount you owe in taxes to the relevant body. Before paying, ensure that you fill the appropriate tax forms for the current year. Usually, the IRS form you have to fill is 1040 if you work as a self-employed freelancer. The deadline for filing taxes on the income you earned the previous year is April 15. Check with IRS to confirm if this is still the case.
Record the total amount owed on the vouchers for tax payments, which are on Form 1040-ES.
As a self-employed freelancer, you have the option of paying your taxes quarterly or annually.
Quarterly payments are ideal for independent contractors who cannot pay the amount at once.
Identify the payment method of your choice. Choose between mail and electronic payment.
Set a reminder, so you do not forget to make the independent contractor's tax payment on time.
Any freelancer who owes more than $1,000 in independent contractor taxes can pay quarterly. You can spread the payment out into four. Make the initial payment in April. Follow this up with the second payment in June. You can then finish by paying in September and January. With this information, you can now work safely and comfortably as a self-employed freelancer in the realization that you know what independent contractor taxes mean. Remember to pay on time to avoid incurring the wrath of Internal Revenue Service (IRS).