When it comes to taxes, there is always a benefit to being well-informed. Whether it is your first time filing a return or whether you have been filing taxes for years, a little information can represent savings for you. One matter in particular where I have seen much confusion is the tax treatment of independent contractors, who have significantly different tax requirements and opportunities than those of traditional employees. As a result, it is important to understand the basic tax implications of being an independent contractor.
Although the roles and responsibilities of independent contractors vary depending on the industry and company, there are several common characteristics that define these taxpayers. Unlike employees, independent contractors do not have Medicare and Social Security Tax (FICA tax) withheld from their pay. They must pay for their own medical insurance and are responsible for their own business expenses. So what does this mean for filing taxes?
Since companies do not withhold FICA taxes from independent contractors’ income, the independent contractors are responsible for paying self-employment tax (calculated on Schedule SE). This responsibility is waived if net earnings for the year from self-employment do not exceed $400. The IRS requires self-employed individuals to file estimated tax payments each quarter (using Form 1040 ES) based on the estimated total of self-employment and income tax for the current year or based on a percentage of the prior year’s tax. Failure to pay estimated taxes each quarter may result in a penalty imposed by the IRS. The exception to this rule is if the taxpayer’s estimated tax due is less than $1,000, in which case quarterly estimated tax payments are not required.
While traditional employees report income (Form W-2) as wages on their individual income tax return, independent contractors report their income (Form 1099-MISC) on Schedule C as gross sales. Certain business expenses can be deducted on Schedule C, such as office supplies, fifty percent of business meals, business travel, depreciation, and vehicle expenses (mileage or actual expenses). If part of the home is used exclusively for business purposes, a percentage of various home deductions (mortgage, utilities, real estate taxes, etc…) would be deductible on Form 8829 and attached to Schedule C.
In addition to Schedule C deductions, there are several other tax benefits available to self-employed individuals. For example, one half of the total self-employment tax is deductible on the return. Independent contractors can also take advantage of making tax deductible contributions to a retirement plan. Since companies do not pay for health insurance for independent contractors, health insurance premiums purchased by self-employed individuals are deductible on page one of their Form 1040.
As an informed taxpayer, your knowledge will help to prevent you from losing out on potential tax savings, as well as helping you avoid adverse tax consequences. If you are an independent contractor or know someone who is, help yourself or them, by being informed about the different requirements, opportunities, and strategies available for the self-employed. IRS Publication 334, Tax Guide for Small Businesses, provides additional information about federal tax laws that apply to independent contractors. This publication can be accessed at www.irs.gov
Be aware that the IRS carefully scrutinizes the independent contractor versus employee relationship and there can be serious tax consequences, especially for the employer, if the situation is handled incorrectly. Please do not hesitate to contact our office for more information and for any questions that you may have.