As an independent contractor, paying taxes may not be the most exciting part of running your own business, but it's a necessary part of the job. Taxes can be complicated, especially when you're self-employed, but understanding the basics can help you avoid surprises and stay on top of your finances. In this article, we'll cover everything you need to know about taxes for independent contractors, from calculating your income tax and self-employment tax to deducting business expenses and filing common tax forms.

What is an independent contractor?

An independent contractor is someone who works for a client or business under a contract rather than as an employee. In other words, independent contractors are in charge of handling their own business expenses, client acquisition, and taxation of their earnings.

How do independent contractors need to pay taxes?

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Independent contractors are considered self-employed, which means they must pay both income tax and self-employment tax on their earnings. Independent contractors must handle their own tax payments because, in contrast to traditional employees, taxes are not deducted automatically from their paychecks.

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Understanding Taxes for Independent Contractors

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What is Income Tax?

Income Tax is a direct tax on income earned by individuals, businesses, and other entities. It is based on taxable income after deductions and exemptions and is used to generate revenue for the government to fund public services and programs.

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How to Calculate Your Income Tax 

Calculating your income tax as an independent contractor is similar to calculating taxes as a traditional employee, but the process can be more complicated due to the variability of your income. Independent contractors need to estimate their total annual income and subtract any eligible deductions or credits to determine their taxable income. They then use the tax brackets to calculate their federal income tax owed.

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Important Income Tax Deadlines to Keep in Mind:

You must submit your Federal Income Tax return by April 15th of every year if you are an independent contractor. In order to avoid penalties, you must also pay any taxes you owe by this date.

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Understand Self-Employment Tax

Self-employment tax is a tax that independent contractors pay in addition to their income tax. This tax is used to fund Social Security and Medicare, which are typically paid by employers on behalf of traditional employees.

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Related: Taxes for the Independent Contractor: Deductions, Credits, and Forms Explained

How to Calculate Your Self-Employment Tax

To calculate your self-employment tax, you need to estimate your net income (total income minus eligible deductions) and multiply it by the self-employment tax rate. As of 2021, the self-employment tax rate is 15.3%.

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Important Self-Employment Tax Deadlines to Keep in Mind:

Self-employment taxes are typically paid in quarterly installments throughout the year. The due dates for these payments are April 15th, June 15th, September 15th, and January 15th of the following year.

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Related: Don't Miss a Deadline: Everything You Need to Know About Tax Filing and Extensions

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Estimated Quarterly Taxes

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What are Estimated Quarterly Taxes?

Independent contractors pay ‘’estimated quarterly taxes’’ to cover their self-employment and income taxes throughout the year. These payments, which are based on your estimated yearly income, can assist you in avoiding underpayment penalties.

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How to Calculate Your Estimated Quarterly Taxes:

To calculate your estimated quarterly taxes, you need to estimate your total annual income and subtract any eligible deductions or credits. You can then use the tax brackets to determine your federal income tax owed, and calculate your self-employment tax based on your net income. Finally, you divide the total tax owed by four to determine your quarterly payment.

Here's an example on how to calculate your estimated quarterly taxes:

Let's say you are an independent contractor and estimate that your total annual income for the year will be $80,000. You have eligible deductions and credits totaling $10,000. This means your taxable income is $70,000.

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Related: Top 15 Tax Deductions and Write-Offs for Self-Employed 1099 Entrepreneurs

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To determine your federal income tax owed, you can use the tax brackets for the current year, which can be found on the IRS website. For this example, let's assume you are in the 22% tax bracket. This means your federal income tax owed is $15,400.

Next, you need to calculate your self-employment tax based on your net income. Self-employment tax consists of Social Security tax and Medicare tax, which are currently at a combined rate of 15.3%. However, you can deduct half of the self-employment tax as an adjustment to income.

To calculate your self-employment tax, you first need to calculate your net income by subtracting your business expenses from your total income. Let's say your business expenses for the year are $20,000, which brings your net income to $60,000.

Your self-employment tax owed would then be calculated as follows:

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Net income ($60,000) x 0.9235 = $55,410

$55,410 x 0.153 = $8,464.23

Half of self-employment tax = $8,464.23 / 2 = $4,232.12

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So your total estimated quarterly tax owed would be the sum of your federal income tax and half of your self-employment tax, divided by four:

($15,400 + $4,232.12) / 4 = $4,408.53

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Therefore, you would need to make estimated quarterly tax payments of $4,408.53 to the IRS. 

It's important to keep in mind that this is just an example and your actual tax owed may vary based on your specific situation.

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Important Estimated Quarterly Taxes Deadlines to Keep in Mind:

Estimated quarterly tax payments are due on the same dates as self-employment tax payments (April 15th, June 15th, September 15th, and January 15th).

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Common Tax Forms and Documents for Independent Contractors

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1099-MISC:

A 1099-MISC form is a tax form used to report income earned as an independent contractor. This form is typically issued by clients or companies that paid you $600 or more during the year.

W-9:

A W-9 form is a form that you provide to clients or companies to request payment as an independent contractor. This form includes your name, address, and taxpayer identification number.

Schedule C:

A Schedule C form is a tax form used to report your business income and expenses as an independent contractor. This form is used to calculate your net income and determine your taxable income.

Form 1040-ES:

Form 1040-ES is a form used to make estimated quarterly tax payments as an independent contractor. This form can help you avoid underpayment penalties and stay on top of your tax obligations throughout the year.

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Related: What is IRS Form 1040-ES? Understand Estimated Income Tax

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Tips for Simplifying the Tax Filing Process

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Keep Accurate Records

Keeping accurate records of your income and expenses can help you stay organized and simplify the tax filing process. Make sure to save all receipts, invoices, and other documentation related to your business expenses.

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Related: How To Write Off Meals and Entertainment As A Business Expense

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Use Tax Software

You may do your tax calculations more accurately and quickly by using tax software. There are various solutions available, including more options available for complicated tax issues and even free software for simple tax forms.

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Hire a Tax Professional

If you're feeling overwhelmed by the tax filing process, consider hiring Better Accounting Solutions a tax professional expert to help you navigate the process. We can help you identify eligible deductions and credits, and ensure that you're filing your taxes correctly.

Taxes can be intimidating and complicated to pay as an independent contractor. To complete your tax obligations and prevent any surprises, it's important to know the basics of taxation. Maintaining accurate records of your income and expenses all throughout the year is one of the most important ways of making sure that you stay on top of your taxes. This can assist you in carefully calculating your tax liability and ensure that you don't overlook any significant credits or deductions that could reduce your tax liability. 

While it's possible to navigate the tax process as an independent contractor on your own, hiring a tax professional can provide added peace of mind and ensure that you're taking advantage of all eligible deductions and credits. A professional tax preparer can also help you avoid errors on your tax return and minimize your chances of being audited by the IRS. Investing in a reputable tax professional can ultimately save you time and money in the long run, while also helping you stay on top of your tax obligations

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We’re so happy you found this article informative! Head back to our blog page to learn more tips, tricks, and guidance on accounting to maximize your business’s growth and development. 

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