Independent contractors are self-employed individuals who provide a service to a client in exchange for an invoiced payment: their clients are usually individuals or a company of any size. Independent contractors are so-called because of their independence from any other entity. They run their own company and are not on another company’s payroll. This method of employment distinguishes independent contractors from employees.
Since they do not have another company paying them on their payroll, independent contractors do not have anyone withholding income taxes, as an employer would with an employee. Contractors also do not have a company making contributions on their behalf to social security. Depending on their country's laws, they may owe the government higher social security payments than employees. This means that contractors are liable for their taxes and must file and pay taxes annually.
Every country has unique laws regarding employment, self-employment, and taxes. This article is based on U.S. tax laws and will help independent contractors and self-employed individuals in the United States. Check with the country laws – including the laws of any countries you may intend to travel to for work, and always consult with a tax professional before filing your taxes.
What Taxes Do Independent Contractors Pay?
Independent contractors pay taxes on the income they earn throughout the tax year, just like employees. When an invoice payment is made to the contractor, there is no income tax withholding. Instead of tax withholding each paycheck, contractors can pay quarterly estimated payments. This way, a large amount of the taxes owed will already have been paid four times per tax year, so when it comes time to pay taxes, there won’t be as many taxes owed, and you shouldn’t owe penalties for failing to pay quarterly payments.
In the United States, self-employed individuals also pay self-employment taxes. Self-employment taxes fund Medicare and Social Security. The taxes collected to fund Medicare and Social Security are FICA taxes (Federal Insurance Contribution Act).
Employees also pay FICA taxes. However, their employer pays half the FICA taxes – 6.2% for the employer and 6.2% for the employee’s social security, up to $147,000, and 1.45% each for Medicare. Self-employed individuals pay the employer and employee portions of FICA taxes for a total of 12.4% for social security and 2.9% for Medicare for a combined self-employment tax of 15.3%. Taxpayers earning more than $200,000 pay an additional 0.9% for Medicare.
In addition to self-employment taxes, self-employed workers pay income taxes on their earnings. In the United States, taxpayers owe federal income taxes and, in most states, state income taxes. The tax rate for states varies, and some are progressive – a higher rate for higher income. The federal tax rate is a progressive rate calculated from tax tables and is a different tax rate for single, married, and married filing jointly or separately filers.
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Personal vs. Business Expenses: What To Keep In Mind
Only business expenses can be deducted from business income. If you use office equipment or anything used for business purposes sometimes, the expense will not be 100% deductible. For example, if you use a vehicle for work purposes only part of the time, the costs for that vehicle can only be deducted for the time it was used for business purposes.
A Detailed Breakdown Of Business Tax Deductions
Deductions, also known as write-offs, are eligible expenses deducted from income that reduce the taxes owed. A tax write-off for independent contractors may include all the costs that the contractor paid to do business.
What Can an Independent Contractor Write Off?
Independent contractors can make certain tax write-offs, which will reduce the amount of taxes they owe.
Tools and Equipment
A contractor may use a computer that connects to the internet with an internet utility in a home office. Those expenses are all deductible. It gets tricky with items used for business purposes only part of the time.
You may purchase a mobile device and use it for business half the time. The total deduction for that device would be 50%. If the device costs $200 and is used for personal use half the time, then only $100 can be deducted. You may need to depreciate the expense over several years for expensive or long-lasting tools.
If you’ve used the services of an accountant or law firm, the costs can be deducted from your income.
Making a home office deduction can help simplify deductions of utilities. If the office space is 20% of the home, then the utilities that serve the whole home will be deducted by only that amount. If the monthly internet bill is $100, in this example, $20 will ultimately be deducted from business income for that utility expense. There may be utilities or repairs for only the home office, which are fully deductible.
The costs of any insurance you may have for your business can be deducted.
Health Insurance Premiums
Self-employed individuals in the United States may also deduct 100% of their health insurance payments. This deduction is made before the standard or itemized deductions so that it will lower your adjusted gross income (AGI). To be eligible for this deduction, the taxpayer and their spouse must not be eligible for employer-subsidized health plans.
Qualified Business Income
QBI, Qualified Business Income, allows eligible taxpayers to deduct up to 20% of their qualified business income, real estate investment trusts, and publicly traded partnerships.
As mentioned above, self-employed persons need to pay FICA taxes in the form of self-employment taxes which total a tax of 15.3%. The dollar figure of this amount may be deducted from taxes. Self-employed individuals may deduct half of their self-employment income from their net income.
Phone Bills and Internet
You may claim the home office deduction but still use your phone or internet data usage on the road. In this case, the time spent on the phone and connecting to the internet using your plan’s data usage should be recorded, and this dollar amount can be deducted from income.
The costs of advertising your business are deductible from income.
The cost of meals for business purposes may be deducted. Usually, 50% of the cost can be deducted. Until the end of 2022, 100% of the meals can be deducted as long as the meals are from a restaurant.
Travel costs for business may be deducted as long as the travel is for a planned business purpose, is away from your home or business location, requires you to sleep somewhere, and the trip lasts longer than a typical workday.
For your vehicle to be tax-deductible, you must use it for business or deduct only the percentage of time it is used for business purposes. Otherwise, mileage can be deducted using the standard mileage rate and multiplying that by the miles driven for business.
Self-employed people have some options for retirement plans, including SIMPLE IRA and SEP IRA.
Record-keeping for Your Deductions
To avoid underpayment of taxes or a tax audit, keeping good records throughout the year is important. This means the careful collection of all of the following:
- Receipts for tools or materials purchased for the business
- Receipts or invoices for services that help you run your business
- Fees paid for software, apps, memberships, or subscriptions used for the business
- Legal expenses
- Payments toward health insurance premiums and retirement plans
- Utilities such as electricity bills and internet connections
Not only can all of these records help you in the event of an audit but will help you stay organized for tax season when it’s time to add up all of your expenses and make eligible tax deductions.
Managing taxes can be complex and challenging. To make sure your taxes are correctly filed, good record-keeping is essential. There are numerous tax deductions independent contractors can make. Write-offs are deductible expenses the government allows that can help reduce tax liabilities. These deductions reduce the taxes owed by being deducted from taxable income. Assuming it’s 100% deductible, the amount of money spent on tools, supplies, and other expenses spent on the business can be deducted from income.
To maximize savings at tax time, keep good records throughout the year on income and expenses and save the receipts of anything spent to help you perform your services and run your business. You can always file and pay your taxes yourself, but getting the advice of a tax professional is a wise decision to keep you compliant with tax laws and even to save you more money if they can find more deductions for you.
Write-offs for independent contractors can significantly reduce tax liabilities, so be sure to keep good records of expenses whether you have someone to prepare your taxes or you are preparing and filing them yourself.
If you are an independent contractor, you can get help invoicing clients and getting paid in the currency of your choice. Skuad can help you with contracts that are compliant with local laws.
For companies hiring independent contractors, Skuad offers independent contractor management to help pay contractors. To see how Skuad can help you, get a demo today.