Here’s everything you need to know about the 1099 and filing taxes as an independent contractor
Filing taxes is stressful enough even if you have virtually little to nothing to worry about, so filing as an independent contractor could be even more stressful. But if you know what to expect and how to prepare, you won’t feel so overwhelmed once tax season arrives.
If you worked as a contractor for a federal agency but were unable to work due to facility closures and/or other restrictions, you might be able to receive reimbursement for paid leave as a result of the second stimulus program. Keep up to date with the third stimulus payment. Learn about the Pandemic Unemployment Assistance (PUA) program and unemployment benefits for self employed taxpayers as a result of the second stimulus payment package here.
DETERMINING YOUR EMPLOYMENT STATUS FOR TAXES:
The first thing you should determine is if you’re considered a self-employed taxpayer or not; you likely get paid as an independent contractor rather than an employee. Credit Karma reminds us that as an independent contractor, you’re automatically considered self-employed by IRS standards. This is because as a business owner or contractor who provides services to other businesses, you aren’t an employee of any company.
Not all self-employed business owners are independent contractors. If you’re not sure whether a company you work with considers you an independent contractor, read over your contract or reach out and ask.
If you’re a self-employed individual, you’re subject to a different set of tax payment and filing rules than employees — including additional forms to file and estimated taxes. Failing to pay your estimated quarterly taxes or underpaying them may result in a tax penalty, and the size of the penalty depends on how much you underpaid.
DIFFERENCES BETWEEN FILING TAXES AS AN EMPLOYEE AND FILING TAXES AS AN INDEPENDENT CONTRACTOR:
There are four main differences between filing taxes as an employee and filing taxes as an independent contractor. These include:
- Reporting self-employment income and deductions on Schedule C (form 1040)
- Paying self-employment tax on Schedule SE
- Paying quarterly estimated taxes
- Receiving form 1099-MISC rather than a W-2
We’ve written about the latter before in our blog titled Sending Form 1099-Misc or Form 1099-NEC, so we’ll be referencing that article throughout. In the meantime, let’s take a look at what each of these points means for you as an independent contractor, starting from the first point and making our way down.
Reporting Self-employment Income And Deductions On Schedule C (Form 1040):
As an independent contractor, you’re required to file Schedule C (Form 1040) along with your personal tax return. You can download a PDF of Form 1040 here.
This form is used to report income or loss from a business you operated or a profession you practiced as a sole proprietor. A sporadic activity, not-for-profit activity, or a hobby does not qualify as a business. An activity qualifies as a business if:
- Your primary purpose for engaging in the activity is for income or profit.
- You are involved in the activity with continuity and regularity
Remember that an independent contractor is considered to be self-employed, so in effect, you are running your own one-person business. Any income that you earn as an independent contractor must be reported on Schedule C. You’ll then pay income taxes on the total profit.
While being an independent contractor means you have to pay more in self-employment taxes, there is an upside: You can take business deductions.
Some examples of business deductions include:
- health insurance
- home office deductions
- deductions for your phone bill
These expenses reduce the amount of profit on which you pay income taxes. You’ll report these deductions along with your income on Schedule C.
Paying Self-employment Tax On Schedule SE:
A big financial drawback of self-employment is paying self-employment taxes. HR Block explains that self-employment tax is how you cover Social Security and Medicare taxes for yourself.
In an employee-employer situation, both parties pay a portion of these taxes. However, since you’re self-employed, you’re responsible for both halves. You’ll actually get to deduct the employer portion in the end, falling in line with what was mentioned at the end of the previous point.
Nerd Wallet, quoted earlier, says the current self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare — a total of 15.3% just in self-employment tax. The good news is that while you need to pay the entire 15.3% tax, you can take half of what you pay as a deduction from your income.
You’ll report self-employment taxes by filing Schedule SE with your personal tax return. These taxes are in addition to any income tax that you’ll owe. You can access Form 1040 ES here.
Paying Quarterly Estimated Taxes:
Next on the list is the tax payments you need to make regularly throughout the year. This is known as your quarterly estimated taxes, and are used to pay income tax and self-employment tax.
Generally, if you are an employee whose only income is from a W-2 with taxes withheld, you will not have to worry about making estimated income tax payments as this is done through your employer. However, this isn’t the case. The most common taxpayers who are subject to make estimated tax payments are the self-employed who may receive income on a 1099 form, such as a 1099-NEC.
In addition to being self-employed, there are other types of incomes that a taxpayer could generate throughout a given tax year that may be subject to estimated income tax payments via periodic payments. The following are some of the types of incomes besides self-employment (independent contractors, gig economy):
- Bank interest income
- Dividend income
- Rental income
- Some alimony income
- Unemployment benefits or income
- Taxable portion of Social Security income
This is important to know so you can a) avoid tax penalties at the end of the year and b) know the dates to make payments and keep a consistent schedule.
The deadlines for making your quarterly estimated tax payments are:
– April 15: for income earned from January through March
– June 15: for income earned in April and May
– Sept. 15: for income earned from June through August
– Jan. 15: for income earned from September through December in the prior year
“If you do not pay enough tax throughout the year via estimated tax payments to cover your tax liability, then you will be charged a penalty by the IRS,” says eFile on it’s article on self-employment, independent contractors, and taxes.
Some things to keep in mind when handling quarterly estimated taxes:
- If you do not pay enough tax throughout the year via estimated tax payments to cover your tax liability, then you will be charged a penalty by the IRS.
- The tax penalty is calculated on your tax return, and added to the amount you owe or subtracted from your tax refund.
- You may have to pay estimated income tax four times throughout the year (quarterly) because you do not have taxes withheld from your pay by an employer.
- You can make your estimated tax payments electronically online. You can pay online using a credit card, debit card, or electronic funds withdrawal. If you make your payments online, you do not have to mail vouchers to the IRS. You can access the IRS payment portal here.
Receiving Form 1099-misc Rather Than A W-2:
Instead of a W-2, every client that paid you more than $600 is required to send you a 1099 contractor form. Clients that paid you less than $600 don’t have to send one. In theory, if you add up all the 1099s you receive, it should be equal to your gross income for the year. So this form details how much you were paid throughout the year and can/should be used to double-check that you’re reporting all of your income earned through the year. More wise words from Nerd Wallet.
THINGS TO KEEP IN MIND:
- If a client doesn’t send a 1099:Some clients may not send one, even though they’re supposed to. Ultimately, you’re responsible for reporting all the income you earned during the year to the IRS, whether you received a 1099 or not.
If an employer did not send a 1099-misc, or other 1099 form, by the end of February, the IRS says you must contact it to let it know. To learn more about how to handle this type of situation, click here.
- Don’t Forget About Local Tax Regulations:You must also account for local taxes. Depending on where you live, you may have to pay state, county, and city taxes, too. Consult with your local tax office to determine your local obligations. Shared Economy Tax says that your total tax bill can equal as much as 40% of your income! That sounds high, but federal, state, and local taxes can add up fast.
- Set aside a percentage of your income:Many small business owners set aside 30% of their gross income to cover tax payments. Setting aside a percentage of your income in this fashion is a prudent move.
Keeper Tax summarizes this topic well: One of the most frustrating aspects of being an independent contractor is having tax season roll around and feeling bewildered by all that must be done.
As we mentioned at the outset of this article, tax season could easily make you feel overwhelmed. No one like the possibility of being hit with steep penalties and fees (especially if you have to sort out stuff with the IRS if you accidentally miss your tax deadline).
But remember that there is always someone out there who can answer your questions or give you advice. We recommend working with a licensed tax professional to make sure your taxes are filed properly, and you don’t incur any penalties from the IRS.