October 11, 2021
How to Pay Taxes as an Independent Contractor
Did you know as an Independent Contractor, You are now a business!?
Whether it’s a side hustle or your new career path, things change with taxes when you agree to work as an independent contractor. The IRS requires businesses and individuals to report any payments made to any individual in excess of $600 to be reported on form 1099. As an independent contractor, you should be completing form W-9 for the individual paying you and you should receive a form 1099 to file with your taxes.
Having income you’ve earned reported on a 1099 means that you are now in business for yourself! Depending on the amount, and if you expect the income stream to continue will lead you on how you report this income on your income taxes. If you have expenses associated with earning the income, you will most likely file a business Schedule C on your tax return. The income minus any associated expenses is your income subject to self employment tax.
Self employment tax is where a lot of people get in trouble at tax time because they don’t realize they have a required amount to pay even if they didn’t “make much”! Here’s what it means and how to make sure you don’t get surprised at tax time.
What is self employment tax?
When you are an employee, you have taxes automatically deducted form your paycheck. You get a W2 at the end of the year. If you have paid enough in, you get a refund. If you did not pay enough in you’ll owe. Part of those taxes are the mandatory social security and Medicare payments. As an employee, your employer pays ½ of the mandatory amount. In total, 15.3% goes toward social security and Medicare 7.65% paid by you, 7.65% paid by your employer.
As a self employed individual, you will pay ALL of the 15.3%. Just like your wages the amount is mandatory, so you will need to pay it even if you don’t owe income tax. That’s a separate tax.
So let’s say that you make $6,000 on your side gig this year. You have $1,000 in expenses associated with earning that money. Your amount subject to self-employment AND income tax is now $5,000. Meaning that you are required to pay a minimum of $765.00 ($5,000 X .153) in self employment taxes. Now let’s modestly estimate that you are in the 10% tax bracket. That’s an additional $500 in federal income tax due. You now have a $1,265 bill due.
We find that many people are surprised by this, have not set the funds aside and wonder how this could have happened. (The numbers are usually much bigger than the example!) Tax planning and estimated tax payments are the solution to keeping on top of your business income. Yes, as an independent contractor, you are in business and responsible for your taxes yourself!
Estimated Tax Payments, are they required?
So the answer to if they are required depends on a number of factors, but if you have been in business for any length of time, they are likely required. As a new business, you may not be subject to them the first year, also depending on a number of factors. Even as a new business owner, you probably do want to pay estimated taxes. This will eliminate the possibility of a huge unexpected tax bill in April!
Taxes are a pay as you go system, just like for every paycheck from your job you pay in, you will want to pay quarterly on your self-employed income. Estimated taxes are paid 4 times per year- April 15th, June 15th, September 15th and January 15th of the following tax year. Paying as you go with the estimated payment system allows you to know exactly where you at and all year and avoid unpleasant surprises. You also have an obligation to pay estimated taxes to avoid late payment penalties. Every situation is different and there are many factors that go into tax planning so it’s best if you consult with a tax professional to help you, especially at the beginning! I’ve seen so many business owners that could have avoided costly mistakes if they had sought help and education early in their business instead of waiting until it seemed big and overwhelming, don’t let this be you.
Get help early to avoid uncomfortable surprises!
If you have been engaged in income producing activities and think that you may possibly be subject to self-employment taxes but aren’t sure. Please give us a call! We help business owners of all sizes with accounting and taxes. As an independent contractor you are definitely in business for yourself and need to understand your tax obligations. Proactive planning allows you to know exactly where you stand, and enables you to focus on money making activities which is why you went into business in the first place. With over 2 decades of tax experience and 3 decades of business accounting we have the knowledge and expertise to help you build your business.