Learning how to pay taxes as an independent contractor doesn’t have to be hard. But let’s go ahead and acknowledge upfront that taxes, in general, are kind of scary.
We’re all trying to do the right thing and no one wants the IRS knocking on their door. Nor do you want to feel like you’re in over your head and it’s just a matter of time before you get carted off to jail — even if it’s white-collar jail.
Before going any further let me just say …
DISCLAIMER: This post is meant for informational purposes only and does not in any way constitute legal tax advice. Each reader should check in with his or her own people e.g. tax attorney, financial advisor, business advisor, accountant, dad, or any other “person” you have at your disposal to check in with before taking action. I can assume no liability for actions taken based on the information contained in this post.
Whew! OK. Basically, I’m going to be telling you about a bunch of shit that I’ve learned, done, and come across since I started paying taxes as an independent contractor in the hopes that it can help you. But it’s just that … my personal advice.
I’ll be honest, was pretty terrified during my first year of freelancing. But getting thrown into freelancing made me have to jump in head first and worry about figuring it out later. Looking back, what’s the verdict? Well, let’s just say that figuring out how to pay taxes as an independent contractor was way less of a hassle than I thought it would be. So let’s get into it
What kind of business are you?
One of the first things you may notice while googling around on the internet for tax information is that a freelancer isn’t mentioned specifically in “types of businesses.” Instead, a freelancer is considered an independent contractor. This is someone who independently takes on contracts with various other firms, businesses, agencies, etc. It’s a form of self-employment.
“OK, great, makes sense, you say … but I don’t see independent contractor listed as a business type either.”
That’s correct. As a freelancer/independent contractor, you are considered a sole proprietor.
That’s great because this is the easiest type of business to set up. There’s no paperwork. The minute you, Jane Smith, accept payment for your services, you are in business as a sole proprietor. Things get a little more complex if you become a partnership or corporation and since I’m not an accountant, my advice to you there is: “See an accountant.”
Will I need an EIN to pay taxes as an independent contractor?
No, certainly not in the beginning. Because you are a sole proprietorship, essentially, a business of one, you’ll do your taxes and whatnot using your personal social security number.
For those who haven’t heard the term before, an EIN stand for Employer Identification Number. It’s also called a Federal Tax Identification Number and is used to identify a business entity. In layman’s terms, it’s basically a social security number but for businesses.
It can be helpful if you’re opening business bank accounts and credit cards and such, but that really isn’t necessary when just starting out. One of the greatest things about self-employment as a freelancer is that you can start off really simple and scale things up as you go.
Is there some kind of ceiling on how much I have to earn before I’m expected to pay taxes as an independent contractor?
Good question. There is but it’s pretty low. If you earn more than $600 in a calendar year from a single client, you’re expected to pay taxes on it.
I’m hoping you’re planning to operate as a successful freelance business owner so you can pretty much expect to pay taxes on all your earnings from your various clients. If you’re doing it right, you’ll be earning a lot more than $600 from each of them.
When do you have to pay taxes as an independent contractor? Is it different than W2 employment?
It sure is! As an independent contractor, you’ll be expected to make a tax payment on a quarterly basis, otherwise, you’ll be subject to a fine at the end of the year if you pay a lump sum.
If you’re going to owe at least $1000 in a year, the IRS wants their money early. Since you don’t know exactly what you’ll earn throughout the year as an independent contractor or what the payment amounts should be, you’ll make what’s call Estimated Quarterly Tax Payments. You make these in April, June, September, and January.
You’ll then file one tax return at the end of the year so don’t stress! It’s not like you have to fill out paperwork 4 times a year. Thank goodness!
How on earth do I estimate what I’ll make?
That can definitely be tricky your first year of trying to figure out how to pay taxes as an independent contractor. Ideally, you’ll be starting out rather small but scaling-up your freelancing business rather quickly. I recommend to my students that they set aside 25% of their income to pay taxes in the first year. This is especially important if you live in a state that does have an income tax. Currently, all but 7 US states have income tax with California and Hawaii topping the list of the highest at 13.3% and 11% respectively.
I had no idea what number to choose for estimated taxes so I just set aside 25% my first year of freelancing and was pleasantly surprised to find I’d over-budgeted for my taxes and had the pleasant decision of putting a lump sum of extra tax money in savings or blowing some of it on a vacation.
After the first year, you’ll have a much better idea of what your tax obligation is each year and you can adjust to where it’s comfortable. But you don’t want to get through the year only to find out that you owe more money to the government.
If the unknown stresses you out you can pay 100% of your last year’s tax liability. So if you owed $6000 last year, make sure you’re paying $1500 quarterly this year in an estimation. If you pay too much, you’ll get some back. If you underpay, you won’t face any penalties, you’ll just owe the rest of whatever you owe.
Talking with an accountant will help you set up the estimated quarterly payment amounts.
Keeping business income separate from your personal life
Even though it’s not legally required as a sole proprietorship, you’ll want to keep as much separation as possible between your personal life and business life.
Separate bank accounts and credit and debit cards are the easiest way to do this. You’ll also want to choose a set starting date. January 1 is ideal but if not just pick the start of the next month once you’ve got things sorted. Make a note of that and you and your accountant can go through things at the end of the year noting that you started to separate everything on May 1st or whatever the date is.
If you don’t separate, at the end of the year you’ll have to comb through all your personal expenditures looking for business stuff to separate out. Don’t worry if things are mixed — they were my first year. I only started in July and didn’t get up and running until August so I had to go through card statements once I started freelancing and specifically identify what certain business expenses were for my accountant.
This wasn’t too bad though because I wrote things down. Definitely make sure to note what you spent on what, and do it often! I bookmark my spreadsheet for the year and it’s just there in my browser to make it really easy to note things down.
For things I pay for monthly and receive invoices for, I note everything down 1x a month. I have a rule that an email receipt or invoice doesn’t leave the inbox, e.g. I can’t delete it or store it in a folder unless noted down.
Most credit card stuff is easy to identify based on the description on the statement. This is one of the main reasons why I pay for almost everything via credit card — there is an automatic notation in writing for what it is. It’s rarer to use cash or check for business but if you do, make sure to note on the receipt or the memo line what it was for in addition to noting it in your tracking document.
Where do I put the money until tax time?
I deposit my tax amount into a separate account so that it’s clearly separated from any of my other money and I don’t touch it. I use Weathfront.com so the money can grow as it waits to be used for tax time. Wealthfront is a robo-investor that lets you set up an investment account and choose a risk score from 1-9. (Use my link to sign up and you’ll get your first $5K managed for free and I’ll get an additional 5K managed for free. I love Wealthfront and recommend them to everyone!)
Obviously, I want my money to be there come tax time and I will need it pretty often (every quarter) so this is not an account I want to go all-in on risk-wise. I choose a pretty conservative risk level and let the money sit there growing until I need to use it each quarter.
What form do I fill out to pay taxes as an independent contractor?
You’ll fill out a regular 1040 when paying taxes as an independent contractor. You’ll include this amount in an extra form attached to your personal income return called a Schedule C. According to the IRS, a Schedule C form is used to report income or loss from a business operated as a sole proprietor. This has to do with how much you’ll owe for Social Security, Medicare, etc. There is also a Schedule SE form that is used to calculate the tax due on your net earnings.
As an employee, you were likely used to receiving a W2 from your employer each January. You’d then use that information to prepare your tax return. As an independent contractor, you’ll receive a form 1099-NEC (formerly a 1099-MISC) from the clients you’ve worked for over the year.
You’ll often have to request it as people will forget. And they’ll have to fill it out based on the information you sent them in a form W9 when you started working together. This is your responsibility to send to them as a part of your onboarding process.
Even if the client forgets or refuses to send you one, you MUST report the income that you’ve made from them. What they do with regard to reporting stuff to the IRS is their business, you want to make sure you’re doing things right on your end.
I have a templated script I send clients each November and again in January. Get that, plus lots more information on how to organize yourself to pay taxes as an independent contractor here.
How do I pay? Can I do this online/from anywhere in the world?
Yes, the IRS does offer an online service and you can send in your tax payment once you set up an online account. You can use debit or credit for your quarterly taxes but note that if you’re paying employment tax you can’t use a debit card.
Wherever possible I use credit cards because even with an extra fee it works out to free money if I’m earning credit card bonuses.
What can I deduct from my independent contractor taxes?
Since you’re your own business as an independent contractor there are a number of deductions you’ll be able to make. However, your best bet will be to speak to an accountant. They are amazing at finding all of your deductible business expenses. Here’s a small list to get you going in case you’re interested in how to pay taxes as an independent contractor by filing yourself:
- Part of your self-employment tax
- Health insurance and some out of pocket costs
- A portion of housing expenses for your home office
- Business expenses
- Can even deduct your accountant fees!
- Ongoing education
Something that’s important to note is that tax deductions on your tax return are not a freebie. Some people tend to think “writing-off” means not paying for stuff. That’s not the case. You’re just not paying taxes on that amount because it’s not considered part of your taxable income.
How much do I have to pay in taxes as an independent contractor?
You’ll need to pay a self-employment tax of (currently) around 15.3%. Self-employment tax is made up of Social Security and Medicare taxes that would normally be deducted from your paycheck if you were a regular W2 employee. Medicare taxes go toward the federal health insurance program for people 65 and older. Normally an employer would pay half as part of employment taxes (1.45%) and you, the individual, would pay the other half for a total contribution of 2.9%. Medicare is funded by the Social Security administration but somehow it’s a separate charge (don’t look at me I don’t make the rules *shrug*).
Since you don’t have an employer paying their portion of employment taxes and it’s not auto-deducted from your paycheck, you’re responsible for paying that tax all yourself as an independent contractor. It’s double because normally your employer would pay half and you would pay half. Now, you have to pay both as if you were the employer. But, you can also deduct the half you pay as an employer. Tax shit is weird you guys, get an accountant!
You’ll also be responsible for paying your standard income taxes. If you’re remote and traveling outside the US, it helps to set up your US home address in a tax advantageous state like Florida, Nevada, or Texas where they don’t have an income tax.
Will I need accounting software to pay my taxes as an independent contractor?
Here’s where I’m going to differ from a lot of people and say NO. Of course, this depends on how many clients you’ve got, expenses, etc., and how fast things are coming in/going out.
I don’t have a ton of overhead nor a lot of new clients/projects constantly starting and stopping throughout the year, So my system from the beginning has simply been to track invoices as well as expenses in a spreadsheet — and hand that and my credit card statements over to my accountant as needed throughout the year.
At the end of the year, he prepares my tax return and I review and sign off on it. Since I’m already paying him for his services, plus the tax obligation to the government, and we have a system worked out using spreadsheets, I don’t see the need for fancy accounting software.
You mentioned separation — do I need a “business bank account”?
No way! Business checking accounts can tend to charge higher fees than personal ones. If you’re able to open a second personal checking account and keep the money in there, that gives you the separation you need.
Ideally, you’re not keeping a lot of money in this account anyway. You’re investing in your business, e.g. buying products and services needed to run your business, or socking it away in retirement and investment accounts.
What if I want to hire other people to do work for me?
If your business is expanding and you’re bringing on other contractors then you’re on the hook for doing all the 1099 stuff for them in the form of requesting that they fill out a W9, and you have to send them a Form 1099-NEC (formerly 1099-MISC).
If you’re getting into this realm, you’ll definitely want to be working with an accountant. The alternative, which I highly recommend, is using freelance platforms like Upwork. Part of their extreme usefulness is that they take care of all that icky tax stuff and you can just pay the person.
When should I get an accountant to help pay my taxes as an independent contractor?
This is up to you and your ability to withstand headaches. I had an accountant from my very first year. To me, it was worth the cost, to not have the headache or stress of wondering if I did my taxes right. I mean, there’s a reason these people go to school and get a degree in this shit. It’s awful.
In my first year, I went generic and went to H&R Block for their accounting service and the cost was around $460. Easily worth the cost because he saved me thousands in deductions I didn’t even know I was allowed to take. In my second year, with business booming, and the switch to a different business structure, I hired a much more expensive accountant, yet even with his high hourly fee, my mind is at ease.
Accountants are also amazing at helping you save with deductions and tax loopholes that are legal and can save you money. They study all the tax code changes each year and keep up with all that stuff so you don’t have to.
So you want to change up your business structure?
There are numerous reasons why you may eventually want to move out of a sole-proprietorship and become a partnership or a corporation.
Make sure you do research into these benefits and understand how this makes sense for YOU specifically.
Do not just incorporate because your other friends/contacts/peers in the space are doing so and you want to feel more grown-up like them.
If you’re making the jump to an LLC, which is usually the next logical step, make sure to get a trusted accountant. Moving away from a sole prop becomes confusing and it’s all-around better to have someone at your side who knows what they’re doing.
Confident that you now know how to pay taxes as an independent contractor?
I certainly hope so! For my final parting words, I’ll just remind you to breathe! It’s not that hard. The absolute best thing you can do for yourself is to keep a spreadsheet noting everything that came in or went out over the year and what bank account or credit/debit card was used. That’s a great start!
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