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As an independent contractor, the Internal Revenue Service will treat you as your own employer. As such, the process for calculating and filing your federal income tax is different from that of an employee. In fact, as an independent contractor, your income tax rate may be higher than that of an employee.
Instead of receiving Form W-2 as an employee does, you will get Form 1099-MISC from your clients. Your clients are generally required to file this form with the IRS and provide you a copy only if they paid you at least $600 during the tax year or at least $10 in royalties, as of 2013. You will need to compute your gross business income for the year on Schedule C, including income for which you received no Form 1099-MISC. Within certain limitations, you are entitled to deduct most of your business expenses, including mileage.
When you are an employee, your employer deducts Social Security and Medicare taxes from your paycheck and pays an equal amount to the IRS on your behalf. As an independent contractor, you are your own employer. If your net business income is at least $400, you must pay self-employment tax equal to the sum of both the employer and employee portions of Social Security and Medicare taxes. You must complete Schedule SE to calculate and report your self-employment tax liability. Self-employed workers pay 12.4 percent of their first $113,700 in self-employment income plus 2.9 percent of all self-employment income in self-employment tax, while employees pay half of these amounts. Like an employee, you must also pay an additional Medicare tax equal to 0.9 percent of your income that exceeds the threshold -- $250,000 if married filing jointly, $200,000 if filing single or head of household and $125,000 if married filing separately.
When someone is employed, the employer deducts taxes directly from each paycheck. As an independent contractor, you generally must pay your estimated taxes quarterly if you expect to owe at least $1,000 in taxes during the tax year. This $1,000 does not include any withholding or refundable credits. You pay estimated taxes by filing Form 1040-ES. You must file Form 1040-ES by April 15, June 15, Sept. 15 and Jan. 15 of the tax year for the quarters ending 15 days before the filing deadline. You must make up for any underpayment of estimated taxes when you file your taxes, by April 15 of the year following the tax year you are reporting. You file using Form 1040, Schedule C and Schedule SE.
You calculate quarterly estimated taxes by estimating your income and deductions for the quarter, instead of the entire tax year. Although you may rely on last year's tax return, if you underpay estimated taxes, the IRS can penalize you. There's an exception to the penalty if you end up owing less than $1,000 for the entire year after subtracting withholding and credits, or you pay at least the smaller of 90 percent of the actual amount due or 100 percent shown on your tax return for the previous year. For example, suppose you paid $2,000 in estimated taxes for the tax year. If you actually owed $2,500 for the same period but paid only $1,800 in taxes for the previous year, you will avoid the underpayment penalty because of the amount you paid the previous year.
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