If you’re self-employed or a freelancer, you likely get paid as an independent contractor rather than an employee. The IRS defines an independent contractor as someone who performs work for someone else while controlling how the work is done. In other words, someone pays you to perform a service or deliver a product, but they only have a say in the outcome. As an independent contractor, there are some unique responsibilities where taxes are concerned. Understanding the guidelines for filing and paying taxes as an independent contractor can help you avoid issues with the IRS. A financial advisor can also help you optimize your tax strategy for your financial goals and needs.
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The key characteristic of an independent contractor is retaining control of how the work they’re being paid to do is performed. With that guideline in mind, there are a variety of careers that offer the ability to work as an independent contractor, such as:
Independent contractor status can apply regardless of how your business is structured. You could be considered an independent contractor if you operate as a sole proprietor, form a limited liability company (LLC) or adopt a corporate structure. As long as you’re not classified as an employee, you can be considered an independent contractor.
Take note: If you hire people to work for you in your business, you’ll have to decide whether to classify those people as independent contractors or employees. Incorrectly classifying an employee as an independent contractor could trigger a tax penalty. The IRS considers someone to be an employee if the person who’s paying them to work can control what will be done by that employee and how it will be done.
Employees typically get paid on a consistent schedule, such as weekly, biweekly or monthly. As an independent contractor, it’s up to you and the payer to agree on when you’ll be paid and how that transaction will take place. For example, the payer may mail you a check, pay you via wire transfer or send payment through an ACH deposit.
These payments are not considered a salary or wages for tax purposes because the vendor doesn’t deduct taxes. That means no federal income taxes, Social Security taxes or Medicare taxes are taken out before you receive the money. Be mindful of how you decide to receive the payment though – some services like PayPal may charge a fee.
When tax season arrives, the payer is required to send you a Form 1099-MISC reporting all of the income they paid you the previous calendar year. This Form 1099-MISC takes the place of a W-2, which traditionally employed individuals receive from their companies. There is one exception to this rule though. If you earned less than $600, you still must report the income, but the payer doesn’t have to send you a Form 1099-MISC. If you work with multiple people or businesses throughout the year, you may receive multiple copies of this form. Payers are required to have these completed and postmarked by the end of January each year.
For tax purposes, the IRS treats independent contractors as self-employed individuals. That means you’re subject to a different set of tax payment and filing rules than employees.
You’ll need to file a tax return with the IRS if your net earnings from self-employment are $400 or more. Along with your Form 1040, you’ll file a Schedule C to calculate your net income or loss for your business. You can file a Schedule C-EZ form if you have less than $5,000 in business expenses.
You’ll also have to pay self-employment tax, which covers the amounts you owe for Social Security and Medicare taxes for the year. For tax year 2024, the self-employment tax rate is 15.3% (this rate is made up of 12.4% for Social Security and 2.9% for Medicare). For tax year 2024, the Social Security tax only applies to the first $168,200 of income. You can calculate your self-employment tax using Schedule SE on Form 1040.
An additional 0.9% Medicare surtax has been applied to high-income earners since tax year 2013. So for tax year 2024, the Medicare surtax applies to single filers and heads of household whose income exceeds $200,000, married couples filing jointly whose income exceeds $250,000 and married couples filing separately with income of $125,000 or more.
If as an independent contractor, you expect to owe $1,000 or more in taxes when you file your annual return, you’ll have to make estimated quarterly tax payments. These regular payments cover your self-employment tax and your income tax liability for the year. The first quarterly tax payment for each tax year is due in April. Subsequent payments are due in June and September, and then January of the following year.
Failing to pay your estimated quarterly taxes or underpaying them may result in a tax penalty. The size of the penalty depends on how much you underpaid.
And remember, you’ll have to pay income tax and estimated quarterly taxes at the state level, too. Failing to pay state income taxes or quarterly taxes, or underpaying each quarter, can also result in a tax penalty.
Deductions lower your taxable income for the year. Independent contractors claim them as business expenses on their taxes. Depending on the kind of business you own, your deductible expenses might include:
Independent contractors can also claim a deduction for health insurance premiums they pay out of pocket. That includes premiums paid for medical, dental and long-term care insurance. If you pay for your spouse’s and children’s insurance, you may be able to deduct those costs, as well. The exception to the rule is that you can’t deduct premiums for health insurance if you have access to a spouse’s insurance plan.
As an independent contractor, you can also deduct personal expenses, such as mortgage interest paid, interest paid to student loans and real estate taxes. You can also get a tax break for contributing to a self-employed retirement plan or a traditional IRA. If you’re looking for a retirement plan option, consider a SIMPLE IRA, SEP IRA or a solo 401(k). These plans allow for deductible contributions, with qualified withdrawals taxed at your ordinary income tax rate in retirement.
If you’re debating between filing your own taxes as an independent contractor or hiring a tax professional, consider your business income and expenses. If you have a straightforward tax situation with few deductions, then it will probably be less expensive to use tax filing software yourself. On the other hand, if your business expenses are complex, you have a high income or subcontract work to other independent contractors, it may be worth the investment to hire a tax pro to avoid any mistakes or errors in your filing.
The tax rules for independent contractors ensure that they’re paying an appropriate amount in taxes, based on their earnings. While the rules are different from what a traditional employee experiences, they’re not overly complicated. Getting familiar with the basics can make filing your taxes as an independent contractor easier to navigate.
Photo credit: ©iStock.com/mapodile, ©iStock.com/SchulteProductions, ©iStock.com/Deagreez
Rebecca Lake, CEPF®Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children. Rebecca also holds the Certified Educator in Personal Finance (CEPF®) designation.
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