Paying Independent Contractor Taxes in 2022: An All-in-One Overview
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Working as an independent contractor can be quite liberating - you get to set your own working hours, choose your clients, and run your business as you see fit.
However, it is very different than being an employee, especially when it comes to paying taxes. Whether you are a small business owner, a podcast host, or a designer offering services to clients, you'll report and pay taxes a little differently than the typical 9-5 employee.
We'll cover the tax obligations and the latest insight for independent contractors in the US to pay their taxes smoothly.
In short, independent contractors work for other people or companies as non-employees. This means the clients hire you to do work for them, but they can only control the outcome of it. The IRS classifies independence in doing work as the most important qualification of contractors. Contractors are in charge of their working hours, equipment, where they work, and how they do their job. Check out our in-depth guide on independent contractors for an overview of getting set up and operating as one.
Contractors are essentially self-employed, regardless of how they choose to structure their business. Independent contractors usually file as sole proprietors on their taxes, but they can also own an LLC (limited liability company).
Independent contractor taxes: an overview
Understanding your tax liability as a contractor can be daunting, especially if you've only worked as an employee before. Being self-employed requires you to get familiar with different taxes since it is your responsibility to pay them yourself. As an independent contractor, you will need to pay both the self-employment tax and income tax.
Simply put, the self-employment tax is the contractors' version of the FICA tax usually paid by employers. Self-employment tax (SE tax) is made up of Social Security and Medicare contributions.
The self-employment tax rate is 15.3%. The rate is made up of two halves: half of the tax (7.65%) is the "employee's" portion, and the other half is the "employer's" portion. As a self-employed person, you have to pay both parts. But the IRS knows that's unfair, so you get to claim the employer's portion (again, 7.65%) as a deduction when you file your tax return. You'll claim it on line 14 of Schedule 1 in your Form 1040.
There is also an additional surtax for Medicare amounting to 0.9% if your income exceeds a certain threshold. For single filers, this is $200,000 USD.
The second tax on your list is the federal income tax. In the United States, the tax system is progressive, which means you pay more when you earn more. There are seven tax brackets in 2021 which range from 10% to 37%.
You can reduce your income tax by claiming deductions from your business income (more on that later on).
Federal vs. state and municipal taxes
The two types of taxes we covered above are federal taxes. Depending on the state you live in, additional state or municipality taxes may apply. Several states don't charge personal income tax, such as Texas, Florida, Washington, and Nevada. State and local regulations vary considerably, so we advise you to check out the tax authority in your state for detailed information.
Quarterly tax payments for the self-employed
Independent contractors pay Social Security taxes, Medicare taxes, and income tax by themselves because there are no employers who withhold these taxes from a salary. The IRS doesn't let you pay all your taxes at once when you file your taxes, because that usually means a very large tax bill that is hard to budget for. Instead, the IRS has you make estimated tax payments four times a year.
You must make quarterly tax payments if, as a contractor, you expect to owe more than $1,000 in taxes for the tax year. Use Form 1040-ES to estimate your tax.
Do you need to pay US taxes as a foreign independent contractor?
Even if you’re a foreigner, your income may still be taxable in the US. There are three possible scenarios:
You work in the US, but your country has a tax treaty with the US
If you perform work in the US because you have a working visa, but you’re not a US citizen, you may be exempt from US taxes or need to pay it at a reduced rate.
This is true if your country has a tax treaty with the US. In that case, you need to fill in Form 8233 - Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual.
This applies to certain items of your income received from sources within the States. If you’re not sure whether your country has a treaty with the US, you can check the list on the official IRS website.
You work in the US, and there’s no tax treaty between your country and the US
If there isn’t a tax treaty between the US and your country, the employer needs to withhold from your payment the full amount of income tax for non-residents, which is 30%.
If there’s any part of the service done in the US, you need to meet these conditions if you want to avoid tax obligations.
- You haven’t spent more than 90 days in a tax year in the US
- You have made $3,000 or less
- You have performed services for an office or entity maintained in a foreign country
Are you unsure whether the income is US-sourced? The IRS says you determine the source of income by determining the location the services are performed at. That means you don’t earn US-sourced income if you’re located in your country or anywhere outside the US while performing work, despite working for a US-based company.
In cases like that, the US employer isn’t in obligation to withhold any taxes from your income or report it.
Note that for any US-sourced income you need to get Form 1099-NEC from your employer so you can report your earnings appropriately.
You live and perform all the work in your country
Form W-8BEN is used for foreign individuals that perform work outside the US. In this case, your income isn’t taxable in the US, and you’re responsible for paying your own taxes in your country.
The purpose of these forms is to prove that you aren’t a US citizen. When working with foreign contractors, it’s critical that the employer collects this form since it protects them if the information you provide is for any reason false or incomplete. That’s why it’s vital to fill in the form accurately.
In case you’re acting as a business entity, you’ll receive Form W-8BEN-E from your employer. This form has the same purpose as W-8BEN and is also used for individuals who are self-employed.
One form is valid for three years and you need to submit a new one if any of the information changes or your collaboration with the employer continues for longer than three years.
Is your contract compliant with the local labor law?
Your employer needs to ensure that your contract complies with your local labor law, too. To avoid employee misclassification and potential penalties and legal issues, they must take local compliance into account, so be sure to check that when signing your contract.
If you want to learn more about working as a foreign independent contractor, check out this article.
Tax deductions for independent contractors
You can claim many business expenses as tax deductions. These deductions can considerably lower the amount of your taxable income, so knowing everything you can claim on your tax return will help you reduce your tax bill as much as possible. Deductions are reported on Schedule C of your Form 1040. We cover the following tax deductions in-depth in our tax deductions guide, but here's a quick overview of some common expenses you can claim:
Home office expenses
Many contractors work from home. Since part of your home serves as a place of business, you can write off a portion of your rent, mortgage, or property taxes. There are two requirements you need to meet to qualify for this deduction. First of all, the home office must be a dedicated place you use exclusively for work. Second, the home office must be the primary place for doing business. Your home office deduction is calculated by determining the percentage of your total home area that the home office occupies.
There is a special simplified deduction for home offices under 300 square feet. For these, instead of detailing the expenses, the IRS lets you claim $5 per square foot, with a maximum allowance of $1,500 per year.
If you pay a health insurance premium out of pocket as a contractor, that payment is tax-deductible. This deduction includes health care and dental insurance for your spouse, defendants, and children under 27 as well. Even your long-term care insurance premiums can be covered in this deductible.
While the purchase of a car itself is not part of the deduction, its mileage, tolls, parking, and other vehicle-related business expenses are all tax-deductible. The IRS's mileage deductible rate is $0.57 per mile.
Advertising and promotion
It may come as a surprise, but the activities you undertake as a contractor to promote and advertise your business are 100% deductible. Qualifying expenses include media ads (print and online), promotional materials such as business cards or leaflets, hiring a designer to make your new website, or posting ads on social media.
As a contractor, you should keep separate bank accounts and credit cards for your business. This makes it easier to separate business and personal transactions, plus, all bank fees, credit card company charges, overdraft fees, and similar expenditures are deductible. You can also deduct transaction fees paid to third-parties such as PayPal.
Depreciation is a term that often comes up but it can sometimes confuse business owners. Depreciation means that when you buy the equipment you use for business, you can't deduct its price all at once. Instead, you spread the cost of your business equipment over the years of use. There are several ways for taxpayers to write off the full equipment costs in one year, but they are more complicated than regular deductions. It's best to consult a tax professional for assistance with properly recording depreciation for your high-value equipment.
Cell phone and internet expenses
If your business operates in such a way that the internet and a cell phone are crucial for your operation, you can deduct these costs. However, make sure to have a separate phone number for the business. In this case, you can deduct the entire cost of the phone plan.
If you are self-employed, chances are you know how important education and professional training are in the modern-day economy. Investing in your skills and credentials is always a good business move, and luckily, the costs of education can be written off your tax bill. You can deduct anything from webinars and books, to professional publication subscriptions.
Business travel expenses are tax-deductible as long as the trip is made for business purposes only and outside your tax home, meaning your area of conducting business. Keep the receipts for transportation, meals and lodging, dry cleaning, and similar expenses.
Tax forms for clients hiring contractors
It's time we dive into the specific tax forms your clients will need to fill out for you each year:
Let's start with Form W-9. The W-9 or Request for Taxpayer Identification Number and Certification is used by companies or clients working with independent contractors based in the United States. If a client will be paying you more than $600 per year, you should provide this form at the beginning of your contract relationship. The W-9 is a way for the client to collect your name, address, and Social Security number or tax identification. The W-9 does not get submitted to the IRS. It's a prerequisite for other forms you will need, because it is used by the client to complete other tax slips.
If you are a contractor located outside the US and your client is a US-based company, you will provide your client with a filled out W-8 BEN or W-8 BEN-E instead of the W-9. These forms, also known as Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting, prove that the contracted person or entity is not a US citizen and performs work outside of the United States. There are two W-8 forms - one for individuals and the other for entities. For an in-depth guide on how to fill out the W-8 forms, check out this article.
Next up is Form 1099-NEC. As a contractor, you'll receive Form 1099-NEC from every client who paid more than $600 to you during a year. The IRS requests the clients to send the 1099-NEC to every independent contractor by January 31st. The form indicates the amount paid to each contractor during the previous year. You'll use these figures to calculate your total income.
Important note: Starting from tax year 2020, companies should use Form 1099-NEC instead of the Form 1099-MISC. The IRS introduced this new form, 1099-NEC (Non-Employee Compensation), specifically for reporting payments to non-employees like independent contractors.
How to file taxes as an independent contractor
The first step in the process of filing taxes is determining if your business made a profit since you only need to file a return for your self-employment income if your net earnings (revenue minus expenses) from the business are over $400. If your net earnings are under $400, you still need to file an income tax return if you have other earnings such as employment income.
You calculate the net income or loss of your business on Schedule C of Form 1040, also known as Profit or Loss from Business (Sole proprietorship). In some cases, you can use the simplified Schedule C-EZ of Form 1040 - for example, if your business expenses are less than $5,000.
When it comes to self-employment tax, which covers Social Security and Medicare taxes, you'll use Schedule SE on Form 1040 to calculate how much you owe based on the self-employment income. If you expect to owe more than $1,000 when you file your annual return, you will need to make the quarterly tax payments we already mentioned.
These estimated tax quarterly payments cover your SE tax and income tax liability. For estimated tax purposes, use the worksheet in Form 1040-ES. In this form, you enter your expected gross income, taxable income, and deductions.
You can file your taxes either by mail or online. We recommend you opt for the online method. It's faster, you don't need to order the forms online, and you don't have to pay by check. For online filing, you need to open an account on the IRS website and transfer the money directly from your bank account or credit card. Filing online also saves all your information, including payment history, on the account so you don't need to worry about papers getting lost.
Make sure to pay your quarterly taxes on time and avoid underestimating them, since both of these actions can result in a tax penalty or an IRS audit. If you happen to overpay the quarterly taxes, you will get a tax refund from the IRS.
Deadlines for independent contractor taxes
There are four quarterly tax payments for your estimated tax. The deadlines for them are:
- April 15th
- June 15th
- September 15th
- January 15th
The deadline to file your federal income tax return is April 15. This deadline has been extended in past years due to the pandemic. If you need more time to file, you can request an extension using Form 4868. Finally, Form 1040 (with Schedule C) is filed at the end of the year, with your final quarterly estimated tax payment.
Tax tips for independent contractors
Now that you are fully familiar with the whole topic of contractor taxes, there are some tips and tricks to keep in mind to make tax time less burdensome for your business and you personally.
Hire a tax professional
If, after all of the forms and deadlines we went over, you don't find yourself wanting to do taxes by yourself, consider hiring an expert. There are plenty of accountants specializing in small business taxes, and some of them have a CPA (Certified Public Accountant) certification. Look for an accountant specialized in your branch of business - their expertise may help you save thousands of dollars in deductions and countless hours browsing the IRS tax guide. Don't forget that tax professionals' fees are tax-deductible.
Keep your tax records
One of the crucial tricks in making the yearly tax filing process less stressful is having your business transactions organized and properly tracked. Tax preparation takes way less effort when your documents and records are under control. Whether your business as a contractor is part-time or full-time, we recommend implementing one of the many small business bookkeeping solutions available. These will enable record-keeping for different business expense categories and make closing the financial year way easier.
Also, we mentioned receipts for tax deductions earlier. Luckily, in the digital age, there's no need to organize and store paper receipts anymore. The IRS accepts digital records, so you can snap photos or scan receipts and invoices and store them in a dedicated folder on your computer or in the cloud.
Make sure you're a contractor and not an employee
When starting as a independent contractor, you need to ensure that according to your contract, you are truly a contractor and not an employee. As an employee, you have the right to different employee benefits, and your employer needs to pay your medicare, social security, and other taxes according to the law.
If you’re not sure whether you should be an employee or an independent contractor, consider the way you work. Does your employer control your schedule, how you work, when, and where? If so, you should have employee status. If they only have control over the results of your work, you’re an independent contractor.
Not all cases are as straightforward, so this 20-factor test may help you determine your status for sure.
Handle your taxes effortlessly through Deel
If you are a contractor working with multiple clients, consider using Deel. Deel offers a streamlined process for both you and your clients, with automated collection of tax documents (such as W-8, W-9, and 1099 forms), smart invoicing, contracts that are compliant with local labor laws, worldwide payments, and simple withdrawals.
Schedule a product tour with a specialist to learn more.
Disclaimer: This article is informational and so should not be considered tax advice. Ask an accountant or CPA for help.