An independent contractor is simply a non-employee who provides services to a business. This includes agents, brokers, and consultants. Independent contractors often work for multiple companies at once or hold different positions within a single business. If this includes you, then you may be wondering what being an independent contractor means for your taxes?
Keep reading to learn the differences between employees and independent contractors, as well as potential tax deductions and other industry-insider tips. Call the tax professionals at Ayar Law today at 248-262-3400 if you need tax help.
Independent Contractor vs. Employee
An independent contractor is an individual or business that provides goods and or services to another entity. This other entity can be another person or a company. An employee, on the other hand, is someone hired by a company to do a specific job via the direction of the employer. The IRS has established 3 general criteria in understanding the difference between an independent contractor and an employee:
If an employer trains and directs work, including hours of work, what tools or equipment to be used, specific tasks to be performed, and how the work is to be done, that worker is likely an employee. A good rule of thumb is that if you can set your own hours, you’re probably an independent contractor.
This factor includes how the worker is paid, whether the worker may work for others at the same time, and whether the worker can incur a profit or loss. A worker who 1) is paid a salary 2) is restricted from working for others and 3) who does not participate in company profits or losses is probably an employee.
Type of Relationship
The presence of a specific contract may indicate an independent contractor, but this factor alone is not controlling. If the worker is entitled to benefits, this would indicate an employment relationship. Another variable is the actual work the individual does. If the work is directly related to the company’s core work, they are probably an employee. For example, a maintenance worker would not be doing ‘company’ work if they were working for a bank.
Now that you know the difference between an employee and an independent contractor, it’s time to talk money and what being an independent contractor means for your taxes.
Salaries vs. Draws
The money you make as an independent contractor is not classified as salary or wages, but rather business income. You don’t get a salary from your business. The money you make from your independent contracting job should go into your business checking account. So, yes this means that you need to have a separate business checking account from your personal account.
Taking money out of your business is called a draw. It isn’t classified as salary because remember, you’re not an employee. You are an owner.
As an independent contractor/owner, the amount you draw doesn’t impact your taxes. You must pay tax on ALL the income of your business, whether you take it out or not. It’s important to remember that as an independent contractor, you do not have federal income tax taken from your draw because you’re not an employee. There are no deductions for Social Security or Medicare, either.
Of course, you can’t get out of paying taxes, and you must still pay federal and state income tax on the income from your work as an independent contractor. This is done through the business tax return.
You will also need to pay Social Security and Medicare taxes. This combined tax is called self-employment tax for independent contractors.
How Being An Independent Contractor Works For Taxes
When you do your personal income taxes you will need to fill out a Schedule C form. This lists your business income from all your contracting work, minus any expenses. Most independent contractors are eligible to file what’s called a Schedule C-EZ, in which you merely list your total income and summarize your expenses. It takes only minutes to complete.
As an independent contractor, it’s important to know what tax deductions you may qualify for. This helps you can keep detailed records like receipts and invoices as proof for when it is time to file your itemized deductions. Deductions may include:
- Occupational operating expenses
- Supplies and materials
- Home office
- Snacks and coffee
- Business-related entertainment expenses
- Business-related travel expenses
- Office cleaning expenses
- Vehicle expenses (like fuel, repair costs, etc.)
- Medical plans/expenses
Paying Income Taxes as an Independent Contractor
First, you have to figure out your business’s net income. This is the income from your work as a contractor and is recorded on the Schedule C form. Income from your work as an contractor is listed, then deductions are taken, and you end up with a net income number.
This number is brought to Line 12 of your Form 1040. It gets added to other income, and then the tax is calculated on your total adjusted gross income.
So, what does being an independent contractor means for your taxes? It means a complicated process of record keeping, quarterly taxes, and forms to fill out. Save yourself the headache and call Detroit’s premier tax law firm today at 248-262-3400.