Working for yourself comes with certain freedoms. As an independent contractor, you can forget the standard 9-to-5 and set your own hours. Rather than earning an annual salary, it’s up to you to set the price of your work—and to sell it. Instead of receiving assignments from a manager, you get to choose who you work with and what type of work you do.
Of course, more freedom comes with more responsibility. If you make more than $400 a year as an independent contractor, managing your business income means managing your taxes, too.
While there’s no need to become a tax code expert in addition to running your own business, understanding the basics of the tax system for self-employed individuals can help you make more informed financial decisions. You’ll avoid unnecessary penalties—ultimately allowing you to make the most of your professional freedom, while reducing the stress of added responsibilities.
What is an independent contractor?
According to the Internal Revenue Service (IRS), an independent contractor is someone who offers services to someone else with control over how the services are performed, such as what, how, and when it will be done. The payer, or client, only has the right to control the result of the work. This means that a client can control what deliverable you create for them, but not the schedule on which you create it.
If you’re an independent contractor, you’re considered self-employed and must pay self-employment taxes, in addition to other forms of tax, depending on your business structure.
Types of independent contractors
There are several ways to structure your business as an independent contractor. Two of the most common structures include:
- Sole proprietor. A sole proprietorship is an unincorporated business with a single owner. With this structure, your business profit and your personal income are the same in the eyes of the IRS. While sole proprietors are liable for all aspects of the business—such as debts and losses—this structure offers an easy and inexpensive way to manage side gigs or freelance work.
- Limited liability corporation (LLC). An LLC is a business structure that separates the owner from the business in order to limit the owner’s liability, but it is taxed as a “pass-through” entity. This means that business profits flow straight through to the owner, and the owner pays income tax on those profits—just like in a sole proprietorship. LLCs are not subject to corporate income tax. An LLC can have one or more owners (called “members”).
Paying taxes as an independent contractor vs. as a full-time employee
Independent contractors and full-time employees share some basic similarities in terms of what types of taxes they pay. But there are differences when it comes to specific tax types, filing taxes, paying taxes, and available tax write-offs.
Types of tax
- How they’re similar. Independent contractors and full-time employees both pay local taxes, state income taxes, and federal income taxes. Tax rates are based on their income.
- How they’re different. As a full-time employee, you split the cost of Social Security taxes and Medicare taxes with your employer. But as an independent contractor, you’re responsible for paying for all of your Social Security and Medicare through a self-employment tax. (The self-employment tax rate is typically around 15.3%).
- How they’re similar. Independent contractors and full-time employees both file a version of Form 1040 every year, which is the US Individual Income Tax Return.
- How they’re different. Independent contractors who are sole proprietors or LLCs must file a specific form, Schedule C (Form 1040), to report business income and losses.
- How they’re similar: In the US, both traditional employees and independent contractors pay taxes as they make income throughout the year—what’s known as a “pay-as-you-go” tax system.
- How they’re different. Paying taxes for full-time employees is relatively simple, as their employer is responsible for withholding estimated payments from their paychecks and sending the money to the government on their behalf. In comparison, independent contractors operate as their own employer, so they are responsible for paying taxes themselves—in quarterly estimated tax payments and/or in an annual tax return.
Tax credits and deductions
- How they’re similar: Both traditional employees and independent contractors are eligible for personal tax credits, such as the child tax credit, and tax deductions, such as writing off charitable donations and retirement contributions. Tax credits are dollar-for-dollar, meaning they directly reduce your tax bill or increase your refund. Tax deductions, on the other hand, lower your taxable income by a percentage depending on your tax rate and other factors. (If someone’s rate is 24%, a $1,000 deduction would lower taxable income by $240).
- How they’re different. Independent contractors may also reduce their tax burden with tax-deductible business expenses, such as rent for a coworking space or digital advertising.
Independent contractor tax deductions
As a self-employed person, you are eligible to “write off” business expenses—meaning you can deduct certain costs of running your business from your taxable income. This effectively reduces the income you pay taxes on at the end of the year. You may want to work with an accountant to ensure you’re aware of all of the tax write-offs available to you. Common tax-deductible business expenses include:
- Advertising and marketing costs
- Bank fees
- Business travel
- Mobile phone and internet costs
- Continued education
- Health insurance premiums
- Home office expenses (including a portion of rent and utilities)
- Tax advice and preparation fees
How to file taxes as an independent contractor
Whether you operate as a sole proprietor or LLC, there are two key ways self-employed individuals file taxes: paying estimated tax payments every quarter and filing a tax return once a year.
1. Pay quarterly estimated tax payments
If you expect to owe more than $1,000 in annual taxes as an independent contractor, the IRS requires you to either pay quarterly estimated tax payments (covering both self-employment tax and income tax) or pay an underpayment penalty fee during tax season (the fee varies based on the amount you underpaid, the due date, and the current interest rates for underpayments, which the IRS publishes quarterly). You can use Form 1040-ES to calculate and pay your estimated taxes to state and federal governments, based on your adjusted gross income.
The deadlines to pay estimates are generally April 15, June 15, September 15, and January 15, unless those days fall on a weekend or federal holiday (in which case the deadline is pushed to the following business day).
2. File an annual return
If you make at least $400 in net profit as an independent contractor, the IRS requires you file an annual tax return. Even if you make less than $400, you may still need to file a tax return; double check to see if you meet any of the requirements in the IRS’s Form 1040 and Form 1040-SR (for those born before January 2, 1957). To file an annual return, use a Schedule C to report your business income and expenses. You must also file a Schedule SE (Form 1040) to report your self-employment taxes.
The deadline to file your annual return is typically on April 15 of the following year.
Independent contractor taxes FAQ
How do independent contractors calculate taxable income?
Your taxable income—an amount used to determine how much you owe in income taxes—as a self-employed person is based on the earnings you made from your services, minus tax credits and deductions.
How are estimated taxes calculated for independent contractors?
Estimated taxes for independent contractors include both income taxes and self-employment taxes, each of which are calculated differently. In 2022, the self-employment tax rate is 15.3% of your net self-employment earnings (your earnings minus business expenses). Your federal and state income tax rate varies based on which tax bracket your taxable income falls within. Note that some states do not levy income tax, while some cities assess income tax on top of state income taxes.
How much money should I keep for taxes as an independent contractor?
Every quarter, estimate your net self-employment earnings and your taxable income. You can set aside 15.3% of your earnings for self-employment tax and then work with an accountant, create a free online account with the IRS, or use a third-party tax software to determine how much income tax you may owe based on your bracket.