What Is an Independent Contractor?
An independent contractor (IC) is simply someone who works for someone else but not as an employee. An employee is someone who works for a business, and the business controls what will be done and how it will be done.
The IRS describes an independent contractor as someone who offers services to the general public. This person is hired to do specific work. You are not an independent contractor if someone else controls what will be done and how it will be done; in other words, the details of how the services are performed.
Tax Deductions for Independent Contractors
Deductions lower your taxable income for the year. Independent contractors claim them as business expenses on their taxes. Depending on the kind of business you own, your deductible expenses might include:
- Advertising costs
- Business insurance
- Vehicle-related expenses
- Legal expenses
- Home office expenses
- Rent or lease payments
- Equipment purchases
Independent contractors can also claim a deduction for health insurance premiums they pay out of pocket. That includes premiums paid for medical, dental and long-term care insurance. If you pay for your spouse's and children's insurance, you may be able to deduct those costs, as well. The exception to the rule is that you can't deduct premiums for health insurance if you have access to a spouse's insurance plan.
As an independent contractor, you can also deduct personal expenses, such as mortgage interest paid, interest paid to student loans and real estate taxes. You can also get a tax break for contributing to a self-employed retirement plan or a traditional IRA. If you're looking for a retirement plan option, consider a SIMPLE IRA, SEP IRA or a solo 401(k). These plans allow for deductible contributions, with qualified withdrawals taxed at your ordinary income tax rate in retirement.
How to file taxes as an independent contractor
1. Gather 1099 forms from your employers
Tax form 1099-NEC (nonemployee compensation) lists the income you earned as an independent contractor working for a specific business. To file taxes correctly, you need to track down 1099 forms from businesses you worked with last year that paid you more than $600. (You still need to file taxes on all of your income, but only businesses that paid you over $600 are required to mail you a 1099-NEC.)
Starting with the 2020 tax season, Form 1099 comes in a few different flavors, though each variation serves the same purpose of recording and reporting your income. Most contractors should receive Form 1099-NEC (nonemployee compensation). However, you could receive a 1099-K if you worked for a business that paid you at least $20,000 over a course of at least 200 individual payments.
2. Calculate your business deductions
Once you've gathered all your records, you can calculate your potential tax deductions. Many of these expenses can be deducted from your total taxable income, which lowers the amount of taxes you owe. Depending on the type of business you run, you should consider making deductions in the following categories:
- Home offices
- Educational materials and experiences, including seminars and conferences
- Gas expenses for business-related traveling
- Health insurance
- Internet and phone costs
We recommend consulting with an accountant or tax advisor who can help you calculate deductions and help you in the event of an audit. Alternatively, tax-filing software includes instructions and information on how exactly to calculate your specific business deductions.
3. Fill out your tax forms
Once you've used your 1099 forms to accurately calculate your income, you'll need to fill out a few additional tax forms to file with the IRS:
- Form 1040. This form reports your individual income to the IRS. Sole proprietors, freelancers, contractors, and any other self-employed persons will file their income taxes with Form 1040.
- Schedule C. This form attaches to Form 1040 and breaks down your business's profits and losses over the course of the year.
- Schedule SE. This form also attaches to Form 1040. It helps you calculate the self-employment tax, or the combined Social Security and Medicare taxes all contractors are required to pay. The self-employment (SE) tax is 15.3% of your annual income.
4. File your taxes
You've assembled all your documents and filled out all your forms. Now it's finally time to file. The IRS explains all your filing options, including a list of IRS-approved electronic filing options like TurboTax and H&R Block. While you can print out all your tax forms and send them and your payment via mail, we (and the IRS) strongly recommend filing online instead. It's faster, easier, and more secure.
As for paying your taxes, the IRS's online payment portal gets the job done the quickest. If you're using tax software, you should be able to pay through the software itself. And if you're working with an accountant, they can help you make the payment.
The Bottom Line
Working as an independent contractor can be a great way to earn a living for people who desire flexibility, don't mind inconsistent earnings, and who can manage their time while potentially juggling multiple clients.
In addition, independent contractors must be comfortable with filing their taxes quarterly with the IRS and paying for their own insurance, plus retirement savings. For some, the freedom to choose projects, and the flexibility of working for themselves, make the challenges worth it.