Key Tax Tips for Independent Contractors
If you are an independent contractor or work with them for your business, it's crucial to understand how taxes work for independent contractors. If you don't follow Internal Revenue Service (IRS) regulations, you could wind up with tax penalties, interest charges or worse. Here's a closer look at what businesses need to know to answer questions like,"Do I have to withhold taxes for independent contractors?" And "as an independent contractor, how do I calculate taxes?"Keep reading to learn more.
A few things businesses should know about taxes when working with independent contractors
When a business hires part-time or full-time employees, the company must withhold a portion of its paychecks for taxes. That's generally not the case with independent contractors. When a business hires and pays an independent contractor, they may ask,"Do I have to withhold taxes for independent contractors?"The general answer? No; it's up to the contractor to handle their tax payments.
“For some businesses, working with independent contractors can be better than hiring employees for tax purposes," says Eric Nisall, who provides accounting, bookkeeping and tax preparation services. “With independent contractors, you might not have to worry about tax withholdings or pay any payroll taxes, unemployment taxes or obtaining workers'compensation/disability insurance. Employees require higher taxes and additional reporting requirements."
Unlike sending the IRS a W-2 form with details on employee compensation, businesses that pay a contractor $600 or more in a year must submit a 1099 form to the IRS and the contractor. This form is then used for tax reporting and calculation purposes.
A few things independent contractors should know about taxes
In most cases, anyone who earns income from doing work in the United States must track and report it to the IRS. When you work as an employee of another company, most of that hard work is taken care of for you, outside of preparing and filing a tax return by the due date every April. Independent contractors have more work cut out for them — and potentially higher costs.
As an independent contractor, it's important to knowhow to calculate taxes. First, independent contractors are required to track their income and are likely to fall under a requirement to submit an estimated tax payment to the IRS quarterly. Self-employed individuals, including independent contractors, send in quarterly payments instead of paycheck withholdings every payday. You could owe a tax penalty if you estimate and pay too little. You'll get a portion back as a tax refund if you send in too much.
“Even if you don't get a 1099-NEC, it's important to track every dollar you earn from your business because you're required to report every dollar earned, and not all contractors are required to be sent a 1099-NEC," Nisall explains. “Doing so helps you prepare an accurate tax return no matter how many clients you work with."
Additionally, as self-employed workers, independent contractors are subject to self-employment taxes. This is a term for a requirement to pay both the employer and employee portion of Social Security and Medicare taxes. Employers cover half of these costs when you have a job somewhere else. If you have a paystub handy, it is likely broken out with its own line item, possibly listed as Federal Insurance Contributions Act (FICA) taxes.
If you do any kind of driving specifically for your business, from a drive to the airport for a work trip to driving customers or meals around as a delivery driver, you can take advantage of a mileage tax deduction. The IRS sets a new deduction value per mile annually. Track your miles driven for business and work purposes to claim this deduction.
Don't forget about insurance
Independent contractors have some benefits and drawbacks when it comes to health insurance. Most independent contractors will need to find their own health coverage, typically through a major insurance company, insurance agent or government insurance marketplace. Those costs can be substantial.
However, depending on your income, insurance policy and location, you may qualify for a health insurance subsidy when you buy through a government marketplace. In any case, independent contractors qualify for a tax deduction for health insurance premiums. Depending on their insurance policy, they may also qualify for a health savings account (HSA), making qualified healthcare expenses effectively tax-free.
Even outside of health insurance, any type of insurance related to your business is tax-deductible. Business insurance is customizable to your unique needs. Professional liability, property, business interruption, business auto, inland marine, umbrella coverage, workers' compensation and cyber insurance are commonly needed by independent contractors. In addition to protecting you and your business, every dollar spent on business insurance is tax-deductible, which leads to tax savings that add up over time.
Always stay one step ahead on taxes
“Don't wait for April to roll around to start working on your taxes," Nisall continues. “Planning ahead with accurate quarterly estimated tax payments and keeping updated accounting records goes a long way in making tax season less stressful, and maybe even cheaper."
Staying on top of your tax and insurance plan year-round is wise for any small business or independent contractor. When you work with the right combination of professionals to support your business, you're in the best position for long-term success.