Important Tax Information for Independent Contractors
Being your own boss is certainly rewarding, but few people think about the extra work
of preparing invoices and tax forms. Independent contractors need to be aware that being
independent of the client company is a special tax situation, and they will need to file
differently with Internal Revenue Service than they might have in the past.
What is an Independent Contractor?
Those who work regularly for the same clients or who only contract under one company
might wonder if they are just an employee. Generally, independent contractors do not
participate in the same programs and activities as the rest of the employees do and are
not subject to the same restrictions. Those who are starting a job should define their
obligations with the clients and make sure the client will be listing them as an
independent contractor in tax forms. If the company pays the contractor more than $600
over the course of a tax year, they will be required to send him or her a 1099 form.
These lines start to blur when the contractor spends much of their time in the office
or conferring with employees on the project. If the employer labels the contractor a
common-law employee and sends them a W2 by mistake, the individual can file Form SS-8 to
dispute the classification.
The IRS defines an independent contractor using the "20 Questions" test, which looks at
a number of factors including the amount of control the hiring company has upon their
work. According to them, an employer "has the right to control or direct only the result
of the work and not what will be done and how it will be done or method of accomplishing
For tax purposes, however, an independent contractor is a business. Most will fall
under the category of sole proprietorship. However if the contractor employs others or is
incorporated, their status may change. Another option might be to run your business
through an "umbrella company" or so-called "pass-through agency," which can give the
option of being either a W-2 or a 1099 for tax purposes, and this can be a great option to
simplify the back-office administration that independent contracting requires. There are
benefits to all of the tax business classifications, but business owners should do
research on which one best fits their organization.
When someone who is an employee receives a W2, income and social security taxes are
already taken out of their paycheck and sent to the IRS by the employer. Those who receive
1099 forms do not have any taxes removed from their wages by an employer. The
self-employed individual must file their income and pay self-employment tax.
Any individual who makes more than $400 from freelancing or independent contracting
work must file a 1040 Schedule C form with the rest of their taxes. This form will help
the individual calculate how much tax they owe. The federal self-employment tax rate is
15.3% but it can vary depending on how much income the person has earned and their
deductions. Deductions are business expenses that can be deducted from the gross income.
See the IRS website for more information.