Independent Contractor Taxes

1099 independent contractor taxes are easy to file if you know what you’re doing. This guide will explain the basics of how to file and how to reduce what you owe.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

What counts as self-employed?

Self-employed includes most types of non-W2 jobs including

  • Entrepreneurs
  • Bricks and mortar small businesses
  • Independent contractors who receive a 1099-NEC
  • Sole proprietors
  • Partners in a partnership
  • People who engage in a skilled trade on their own rather than as an employee
  • Gig economy jobs such as sports officials, rideshare drivers, and grocery deliveries

How much do self-employed people pay in taxes?

You may face a number of taxes in addition to your normal income tax.

What is the self-employment tax?

The self-employment tax rate is commonly cited as 15.3%. This number is accurate in most cases but is really a combination of two taxes.

Social Security Tax

The Social Security tax makes up the largest portion of self-employment taxes. In 2021, the rate is 12.4% on your first $142,800 in income.

The tax rate remains consistent each year unless Congress changes it. The income cap is tied to inflation.

Above the income limit, you do not pay Social Security taxes. If you have a combination of W-2 and self-employment income that takes you above the income limit, your employer should withhold Social Security tax on all of your wages up to the income limit. You may file a claim for a refund if you have too much Social Security tax withheld.

Medicare Tax

The Medicare tax is 2.9% of all of your wages and self-employment income. Unlike Social Security, there is no income cap.

There is, however, an additional 0.9% tax on your income above the following limits:

  • $125,000 if married filing separately.
  • $200,000 if single or head of household.
  • $250,000 if married filing jointly.

These thresholds are fixed by statute and do not automatically increase with inflation.

What other taxes do self-employed people have to pay?

You may also owe the following taxes.

State and Federal Income Taxes

You will owe personal income taxes on either your profit share or your wages plus distributions.

  • For sole proprietorships, partnerships, and S-corporations, you pay your personal income tax rate on your share of the total net profits. You may be eligible for the 20% Section 199A pass-through deduction to offset some of this tax.
  • For C-corporations, your tax is your personal income tax rate on your wages plus your dividends tax rate on your profit distributions.
  • LLCs depend on whether you’ve elected to be taxed as a pass-through (first bullet point) or corporation.

You can calculate your potential federal tax liability using these tax calculators.

Business Income Tax

If you have a business entity other than a sole proprietorship, your state may impose a tax on your business profits. This may apply even if you reinvest the profits back into your business rather than withdrawing them.

Sales Tax

Carefully review the rules for sales taxes for each jurisdiction where you have either a physical presence location, travel to your clients, or otherwise have sales. One key point to remember is that one area may tax services while another may not.

Business Tax Receipt/Licensing Fees

In addition to income taxes, many states, counties, and municipalities charge a flat fee for the right to do business within their borders. This fee usually ranges from $50 to $200.

The fees often apply to any business operating in their area. This may include independent contractors who work for a single company or a service professional who travels to a single client within that area.

What tax forms will you get if you’re self-employed?

There are two major tax forms you will get if you’re self employed.

You get a 1099-NEC if a company pays you directly via cash, check, direct deposit, or similar means.

You get a 1099-K if you get paid by credit card, PayPal, or other third-party payment processors.

Both forms are due on January 31st each year.

What can you deduct on your taxes when you’re self-employed?

Your deductions depend on what kind of business you’re in. These are some of the most common.

Self-Employment Tax

One half of your self-employment tax is deductible for income tax purposes. If you’ve already entered your business income and don’t see this deduction on line 27 of your IRS Form 1040, it’s time to change tax software or fire your tax preparer.

Health Insurance

If you’re self-employed, the cost of your health insurance is an above-the-line deduction if you qualify. This levels the playing field with employees who don’t need to include health insurance premiums paid by their employers in their gross incomes.

Home Office Deduction

If you used an area of your home exclusively for your business, don’t skip the home office deduction. This could include a portion of your electric bill and other utilities. Remember, your bills wouldn’t be as high if you were away from home during the day.

General Business Expenses

Did you maintain a website, buy office supplies, or spend money on advertising? Include these expenses on your Schedule C. Don’t forget transportation expenses between clients or other job sites.

Qualified Business Income Deduction

The Qualified Business Income gives small businesses who aren’t taxed as corporations a 20-percent income tax deduction.

The QBI deduction is available to all types of businesses. This includes retail stores, manufacturing operations, lawyers, lawn care businesses, travel nurses, and side gigs such as sports officials or Uber drivers. For certain types of businesses, the deduction has income limits.

Retirement Contributions

Did you contribute to a retirement plan during the year? See if you qualify for up to $1,000 via the Saver’s Credit. Don’t forget that you can also reduce your AGI by contributing to a traditional IRA, SEP IRA, or individual 401(k).

The easiest options are a personal traditional IRA or increasing your contribution to your salaried job’s 401(k) if you have one.

If you don’t have access to a 401(k) or need to contribute more, you may want to open a SEP IRA or individual 401(k). These are special types of retirement plans for small business plans including sole proprietors with no employees.

What are estimated taxes?

Most people think of April 15th as the due date for taxes, but the reality is that the IRS wants its cut as soon as you get paid. If your income isn’t covered by income tax withholding, you need to make estimated tax payments.

Who has to pay estimated taxes?

You need to pay estimated taxes if you will owe $1,000 or more when you file your tax return. You may not need to pay estimated taxes if you had no income or tax liability the previous year, but it’s good to do anyway to avoid a surprise tax bill.

Common reasons for having to pay estimated taxes include running your own business or having a gig economy side gig that classifies you as an independent contractor like being a Lyft driver, Instacart shopper, or sports official.

What happens if you don’t pay estimated taxes?

If you don’t pay estimated taxes, there are two possible penalties depending on when you actually pay.

Missed or Late Quarterly Payment

The underpayment of or failure to pay estimated tax penalty applies between the estimated tax payment due date and your tax return filing due date. This is an interest charge. The rate is about 2-3% higher than the current federal funds rate depending on rounding and when it was last changed.

Not Paying By Your Filing Deadline

The failing to pay penalty applies if you don’t pay your taxes by your tax return due date. The penalty is 0.5% per month of the outstanding balance. Interest charges also apply on top of this penalty.

How much should your estimated tax payments be?

Your estimated tax payments depend on your income and business type.

  • Default Rule: Most people can avoid estimated tax penalties by paying at least 90% of their current year tax or 100% of their previous year tax.
  • High Income: If your AGI is greater than $150,000 ($75,000 if married filing separately), you must pay either 90% of your current year tax or 110% of your previous year tax to avoid estimated tax penalties.
  • Farmers or fisherman: If at least 2/3 of your income is from farming or fishing, you can avoid estimated tax penalties by paying either 2/3 of your current year tax or 100% of your previous year tax.
  • Household employers: If you have a household employee, include their household employment taxes when calculating your estimated tax payments.

Most people make four equal payments. If your income is uneven, you can annualize your income to match your estimated tax payments to when you actually earned the income. This requires extra paperwork and usually isn’t worth it unless your income is highly variable.

When are estimated tax payments due?

Estimated taxes for calendar year filers are due in quarterly installments on the following dates.

  • April 15.
  • June 15.
  • September 15.
  • January 15 (for the 4th quarter of the previous year).

See Coronavirus Tax Relief for special extensions for 2020 and how to pay the deferred taxes in 2021 and 2022.

Note that the deadline may extend by a day or two if it falls on a weekend or federal holiday.

The easiest way to make estimated tax payments is to make four equal payments on those dates. If you don’t pay the full installment by the quarterly due date, you’ll owe an underpayment of estimated tax penalty. This penalty is smaller than the penalty for not paying in full by your tax return due date, and some people view it as a reasonable interest rate to wait to pay until April 15th. However, depending on your level of financial discipline, you may find it easier to go ahead and pay to avoid being short on funds later.

What income requires quarterly tax payments?

Estimated tax payments cover your total tax liability. Therefore, you should consider all of your income when calculating your estimated tax payments. This includes:

  • Wages (usually covered by employer withholding).
  • Self-employment income.
  • Farming and fishing income.
  • Bank interest.
  • Investment dividends and capital gains.
  • Taxable alimony.

How do you calculate estimated tax payments if you have withholding at a W-2 job?

If your employer withholds income tax, that withholding counts towards your estimated tax obligation. That’s why most employees don’t have to worry about estimated tax payments.

If you have a side job or rental property that only makes up a small portion of your income, you may be able to increase your withholding to avoid having to make a separate estimated tax payment.

To figure your estimated tax payments when you have withholding, take your total tax liability, subtract your expected withholding, and the difference is your estimated tax payment.

Is it better to use this year’s or last year’s income?

It is almost always easier to use last year’s income because all you need to do is divide the tax liability on your last tax return by four and make four equal payments. However, this method could leave you short if your income increases. To avoid this, use a tax calculator to estimate your current tax year liability and either set aside the additional amount in a savings account or make an extra estimated tax payment.

If your income decreases, you have the option to switch to the current-year method later in the year.

What if you pay too much?

If you pay too much because your income went down or you overestimated how much you need to pay, you can receive a refund when you file your final tax return just like you would if your employer withheld too much. You can also opt to apply your refund to your estimated payments for the next tax year.

There is no way to get an early refund if you significantly overpay your estimated taxes. If your income is unpredictable, you may

Where do you send payments?

The IRS has a number of payment options. The easiest option is to set up an account with EFTPS, because you can schedule your payments in advance and have them automatically withdrawn from your bank account on the due date. Note that the initial EFTPS setup takes a few weeks because the IRS sends a PIN by mail that you must have to log in to your account.

To make payments by mail, fill out Form 1040-ES and send your payment along with the payment voucher to the address listed on the form.

Payments by credit card are possible if you’re short on funds. However, the approximately 2% processing fee combined with possible interest are probably greater than the IRS penalties as long as you’ll be able to pay your full tax liability by April 15th.

What’s the best way to handle quarterly tax payments?

  1. Open a savings account just to hold money you’ll use for estimated taxes.
  2. Divide your previous year’s tax liability by 52 and schedule weekly transfers from your checking account into this savings account. Don’t forget to make a catch up transfer if you set this up after January 1st.
  3. Use EFTPS to automatically withdraw your quarterly estimated tax payments from the savings account. The withdrawal should be 25% of your previous year’s tax liability.
  4. You’ve now met your estimated tax obligation by paying 100% of your previous year’s tax liability. (If you’re required to pay 110%, set your quarterly payments to 27.5% instead.)

If your income goes up or your deductions are lower, you’ll have a small April 15th tax bill, but you won’t have to pay a penalty.

What about payroll taxes?

If you collect payroll taxes, including on your own wages (that your business will report on a W-2), the deadlines range from quarterly to semi-weekly depending on your total payroll. This generally only applies to your own pay if you’ve incorporated. It will almost always apply if you hire employees.

Unlike other taxes, the penalties for not depositing payroll taxes on time are severe and can include possible criminal charges. While you can delay paying income taxes knowing that you’ll owe a little interest, it is never a good idea to do this with payroll taxes.

How do I file my tax return?

Most self-employed people will need to add a Schedule C to their Form 1040 individual tax return. If you’ve formed a partnership or S-corporation, you may need to file a Form 1065 or Form 1120-S.

It’s possible to file your return on your own, but most commercial tax preparation software is only capable of handling the simplest businesses. Many small business deductions and tax rules have exceptions, unclear definitions, or other things that are hard to do correctly using check-the-box software if you have no tax knowledge.

What should you consider when choosing online tax software?

  • Cost: All the major online tax filing companies are very similar. If one is free or substantially cheaper, it’s probably a good choice.
  • Live support: If you don’t want to be completely on your own, consider a service that offers live support. However, you may want to give the self-service version a try to see if you actually do need to pay for that extra help.
  • Guarantees: Most online providers will provide a guarantee that you will get the biggest refund and/or that they’ll defend you in an audit. However, this is usually limited to their errors. For example, they had a math error in a form or had incorrect guidance in their questions. You can also sometimes purchase audit defense services for your errors.
  • State returns: If you need to file a state tax return in one or more states, check that they support your state.
  • Other tax forms: You may have other uncommon types of tax situations such as retirement account withdrawals, rental properties, or income from a partnership or corporation you own. You’ll also need to check if each provider offers those forms and whether they charge more to add them.

What are common mistakes people make when filing their own taxes?

Not Paying Estimated Taxes

The federal tax system is pay-as-you-go, if you don’t have income tax withholding through an employer, you need to make quarterly estimated tax payments to cover your tax bill.

If you don’t make estimated tax payments totaling between 90 to 110% of your income tax liability (depending on your income and whether you’re using this year’s or last year’s income), you could have to pay additional interest.

And of course, if you don’t have the money by April 15th, you could pay additional interest and penalties on top of that.

Claiming Personal Expenses as Business Expenses

Many new sole proprietors hear that things like mileage and phone bills are deductible and start deducting them in full. In fact, there are very strict rules that you need to follow.

The main rule is that you can only deduct the business portion of the expense. So for your phone bill, you’d need to figure out how much you use it for personal reasons versus how much you use it for business reasons and only deduct the portion of your bill attributable for business reasons. For mileage, you need to learn the rules for what constitutes business mileage and make sure that you’re not deducting commuting miles between the business and your home. If you don’t, you may face an audit.

Improperly Claiming the Home Office Deduction

The home office deduction os one of the most heavily audited deductions because most people simply do it wrong. To claim it, you must have a portion of your home that you use for nothing but business and meet other IRS rules. You also must have supporting documentation for both your business use and the expense that you claimed.

Expensing Large Purchases All at Once

Even if you’re a cash-basis taxpayer, you may be required to depreciate large purchases over time rather than deducting the full purchase price in the year of purchase. The good news is that the Section 179 election allows you to skip doing this if you don’t make millions of dollars in revenue, but you need to follow the defined procedures to make the election.

Not Reporting Expenses

Don’t skip reporting expenses because you’re afraid of an audit. An audit isn’t that bad as long as you have your receipts and other documentation.

In addition, the tax laws require you to claim your allowable business expenses. This is to avoid people abusing things like the Earned Income Tax Credit, Social Security, and other income-based benefits.

Mixing Personal and Business Expenses

You’re only required to have a separate bank account if you’re a corporation or other legally-separate entity. However, it’s still a good practice if you’re an individual Schedule C filer.

Keeping a separate bank account makes tracking everything easier and reduces what you need to provide to the IRS if they audit your business expenses.

Forgetting Payroll Taxes

If you’re a Schedule C filer, you don’t need to pay payroll taxes for yourself because you don’t take wages. You pay Social Security and Medicare taxes based on your business profit.

However, if you hire employees, you’ll need to obtain an EIN and make payroll tax deposits anywhere from weekly to quarterly depending on your payroll. Failing to do so can result in severe fines and possibly even criminal charges.

Do I need to open a separate bank account to manage self-employment taxes?

It’s almost always a good idea to have a separate business bank account for business expenses. This separates them from personal expenses and makes your accounting even easier.

If you have periodic 1099 income with few expenses, you may be able to open a second personal checking account with your usual bank.  For more complex needs or heavy transaction volumes, you’ll definitely need to open a small business checking account.

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