Are you an employee, or independent contractor? There’s a very big difference when it comes to taxes. Unlike employees, independent contractors do not have taxes taken out of their wages. Instead, you have to remit taxes yourselves.
Forms and pre-work requirements
Before you do any work, you may need to obtain a tax registration certificate (sometimes called a business license). Check with your city and county to find out if you need to register before you can begin operating your business. The certificate notes any local tax you will have to pay. Use this resource to find more payroll information for employers.
When starting a job, the employer should have you fill out federal Form W-9, Request for Taxpayer Identification Number (TIN) and Certification. You will give the employer either your Social Security number or your taxpayer identification number. The employer will use your TIN to report what they pay you to the IRS.
If you do not give your TIN to the employer, the employer can withhold some of your pay. This is called backup withholding. The employer will withhold 24% from your pay and send it to the IRS. In addition, if you give the employer an incorrect TIN, the IRS will notify them to impose backup withholding.
At the end of the year, the employer will send you a IRS Form 1099-NEC, which shows how much they paid you. They will also send a copy to the IRS. However, an employer does not have to send you a 1099 if they paid you less than $600 during the year. Even if they do not send you a 1099, you must report your income.
Independent contractor taxes
When independent contractors are paid, the employer does not take any taxes out of the wages. Even though taxes are not immediately taken out of the wages, independent contractors must still pay taxes. Contractors have to pay taxes no matter what form they were paid in—even if they were paid in cash.
When paying independent contractors, employers do not have to pay any employer taxes.
Employees typically have social security and Medicare (FICA) taxes taken out of their paycheck. Independent contractors, however, pay Self-Employment Tax (SE tax). SE tax is similar to the FICA taxes. With FICA taxes, half of the taxes are withheld from the employee paycheck and the other half is paid by the employer. But with SE tax, you will pay the entire tax. You only need to pay SE tax if your net earnings for the year were $400 or more.
Independent contractors are also responsible for paying federal, state, and local income tax.
If you make more than $3,000 in gross income during the year, you will pay your SE and federal income (FITW) taxes in four, quarterly payments throughout the year. These are called estimated taxes since you will have to decide roughly how much you should pay each quarter. To make quarterly payments, you will use Form 1040-ES, Estimated Tax for Individuals. Penalties will occur if you underpay.
So, who pays unemployment? With employees, employers must pay for worker’s compensation, and federal and state unemployment. Contractors are not required to pay for unemployment and worker’s compensation insurances. If you are out of work or hurt on the job, you cannot use unemployment or worker’s compensation benefits.
You can choose to pay into an unemployment fund. If you do this, you can receive unemployment benefits. For workers’ compensation, some states let independent contractors pay into the fund in order to receive worker’s compensation benefits.
Tax deductions for independent contractors
Independent contractors may be able to apply some small business tax deductions to reduce their tax burden. If you use part of your home for business, you may be qualified for the home office deduction. You may be able to get deductions for operating expenses and travel. To claim deductions, you must submit IRS Schedule A (Form 1040). In addition, if you earn a low income, you may be eligible for the Earned Income Tax Credit (EITC).
You can deduct part of the self-employment tax—the employer-equivalent portion—on Schedule SE (Form 1040). Also on Schedule SE, you can use an optional method for calculating your net earnings to claim a self-employed health insurance deduction.
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