Independent contractors are not employees of another company, which means they have different tax requirements than individuals who receive a W2 from their employer. Independent contractors are self-employed, either as a sole proprietor or business, and offers tax deductions an employee wouldn’t be able to claim. Here are some tax tips for independent contractors:
Keep Your “Independent Contractor” Label
The IRS has very specific rules regarding what makes you an independent contractor over an employee. In order to maintain the label of an independent contractor, you will want to avoid working for a single client – especially if you work at the client’s location and use their equipment to perform the work. You should have several clients at all times, if possible, and use your own equipment.
Don’t Get Classified as a “Hobby”
If you operate your business for five years but don’t show a profit for at least three of those years, the IRS may determine that your business is actually a hobby. In this situation, your tax deductible expenses will only be allowed up to the amount of income earned from your hobby/business.
You Can Also be Employed Elsewhere
You can be self-employed as an independent contractor but still have a regular job. Having a job, or being “on the books” with an employer someplace doesn’t mean you can’t also operate a business of your own.
File Schedule C, Profit or Loss from Business
When you fill out your IRS Form 1040, you will need to file Schedule C to show profit or loss from your business. In some cases, you may be eligible to file a C-EZ, which is a Net Profit From Business form, in place of Schedule C.
Pay Self-Employment Tax
In addition to income taxes, you will probably be required to pay self-employment tax as an independent contractor. On Form 1040, Schedule SE, you can figure the amount of self-employment tax you owe. This is generally the equivalent of paying Social Security and Medicare taxes if you were employed by a company. When determining your adjusted gross income, you deduct half of your self-employment tax.
Pay Quarterly Tax Payments
Independent contractors are required to make estimated tax payments on a quarterly basis if they are expected to earn more than $1,000 during the tax year. If you fail to make your estimated tax payments, the IRS may penalize you for underpayment when you file taxes at the end of the year.
Remember Business Tax Deductions
One of the advantages of being an independent contractor is the ability to deduct your business expenses. You get to deduct expenses that are necessary for running your business, as long as they are also ordinary and common to your industry. In addition to business expenses, if you work out of your home you may be entitled to a home office deduction, which includes deducting a portion of utilities, real estate taxes, repair costs, insurance and rent or mortgage. Keep in mind, if you take a home office deduction, you will have to reduce the cost basis of your home if you sell it, by the depreciation on the house.
Good Record Keeping
The most important thing you can do for your business is to keep good financial records. Not only will it make filing your taxes easier and stress-free, but it will ensure you get all of the deductions you are entitled to and prevent problems if you are audited by the IRS.