So you want to become self-employed? There are a lot of attractions to working as an independent contractor. You can negotiate your own fees, charge for exactly the work you want to do, set your own hours and more. It’s important to remember, though, that there are certain tax issues you’ll have to understand before you start your new business. Read an overview of independent contractor taxes and learn the basics of what you need to know to avoid unpleasant surprises at tax time.
Independent Contractor vs. Employee
The first thing you’ll need to understand is the difference between an employee and an independent contractor.
According to the IRS, an independent contractor is a person who provides services to the general public, and has the right to control the means by which the work is delivered and the result of the final delivered product or service.
If you have a direct supervisor who oversees your work, defines its nature and offers direction, set hours and the like, you are likely not an independent contractor and should not be classified as such. If you are an independent contractor, you will have to pay specialized taxes.
Independent Contractor Taxes
As a normal employee, you will have your income tax automatically deducted from your regular checks, as well as social security taxes and fees for any benefits you receive. Independent contractor taxes are different.
As an independent contractor you will need to estimate the amount of tax money you owe, put it away each pay, and pay out quarterly to the federal government. You will then account for what you have paid at tax time every year and either receive a refund for over-payment, or be responsible for under paying (sometimes with a small penalty).
Higher Tax Rate
Independent contractors pay a higher tax rate than normal employees. This is because in the case of a regular salaried or waged worker, the employer pays a portion of the social security and Medicare benefits owed to the government. Since the independent contractor works for themselves, they must pay both the employer’s and the employee’s portion of this tax. This is colloquially known as the independent contractor tax or self-employment tax.
The only way to avoid paying this extra tax is to become a regular employee and cease operating as an independent contractor. It is, unfortunately, part of the cost of doing business. In the end, the government doesn’t see it as more taxes—their cut is the same; it’s just coming from one person instead of being split between a person and a company.
The forms for independent contractors are similar to, but not quite the same as, those completed and received by a regular employee. Instead of a W-4 form, independent contractors complete a W-9 for each job for which they are contracted. Then, at the end of the year, they receive a Form 1099-MISC to report the payments they’ve received.