Independent contractors are becoming more common as people break free from traditional employment, and with this freedom, more people find themselves needing to pay independent contractor taxes. These taxes require independent contractors to pay more money than those who are employees. However, many find this burden worthwhile as they enjoy the liberties of being their own boss.
Self-Employment Tax
Most people find work with an employer and they assume the employee title. The employer usually pays half of the taxes required under FICA, or the Federal Insurance Contributions Act. Employers must pay 6.2 percent for the Social Security tax and 1.45 percent for the Medicare tax. Employees must pay for up to three taxes that are deducted from their paychecks. This includes 6.2 percent for the Social Security tax and 1.45 percent for the Medicare tax. There’s also a 0.9 percent paycheck deduction for the Medicare surtax for employees who annually earn more than $200,000 for individuals, $250,000 for a married person filing a joint return, or $125,000 for a married person filing an individual return.
Since an independent contractor serves as their own boss, there is no employer to help cover costs. Therefore, the independent contractor taxes, or self-employment taxes, must be paid. Individuals must pay this tax when their business income is $400 or more than their business expenses. Self-employment taxes require that independent contractor income is reduced by 12.4 percent for Social Security taxes and 2.9 percent for Medicare taxes. The income subject to the tax is usually 92.35 percent of an individual’s income after taking the permitted tax deductions.
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Estimated Taxes
When a person is an employee, their employer makes the necessary paycheck deductions to ensure that the government receives tax payments on their behalf throughout the year. According to the Internal Revenue Service (IRS), independent contractors must also make payments throughout the year, which are referred to estimated tax payments. Individuals are required to make these payments every quarter throughout the year if they usually owe more than $1,000 in taxes when filing a tax return. Failure to make these required payments result in the individual being charged a penalty that is based on the amount of tax owed.
Tax Deductions
The heavy tax burden that independent contractors faced is somewhat ameliorated by the numerous tax deductions that are allowed. Independent contractors are allowed to deduct one-half of the self-employment tax when filing Form 1040 and can deduct 100 percent of the premiums for health insurance. Deductions can be made if an independent contractor has a principal place of business which can include a portion of the home or an apartment that is exclusively used to conduct business. Deductions can include rent, insurance, utilities, mortgage interest, repairs, painting, depreciation, and the business part of the real estate taxes. Independent contractors are allowed to deduct the cost of driving from their principal place of business to meet a client or to another location used for work purposes. This cost includes mileage, parking, and any tolls that were paid.
Independent contractors reap many benefits, but with them come some consequences that employees do not have. Those choosing to be more independent in their working lives must adhere to the additional rules and costs of having independent contractor taxes.
