Tax Responsibilities of Independent Contractors

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What Makes an Independent Contractor

The employment category of a worker, independent contractor or employee, is determined by who controls what the worker does. Generally, if the employer is not controlling when, where or how work is done, then the worker is considered an independent contractor. Independent contractors are often self-employed individuals. On the other hand, if the employer controls when, where and how the work is done, the worker should be be considered an employee. The important factor that divides independent contractors and employees is who controls the work being done.

Whether a worker is working full-time or part-time does not affect the employer-employee relationship regarding the employment category of the worker. An independent contractor can be working full-time for an employer, but the employer will not be determining when, where and how the work must be done. Frequency of payment or their amount also does not determine whether a worker is an independent contractor or an employee.

If a job can be conducted independently, employers may choose to use an independent contractor instead of an employee because they will not be required to withhold and pay payroll taxes on behalf of the worker. Many times, employers report their employees as independent contractors to relieve their tax reporting requirements and their tax responsibilities towards their employees. However, the IRS charges heavy penalties for the underpayment of payroll taxes and the wrongful categorizing of employees as independent contractors.

Tax Responsibilities of a 1099 Contractor

Given the way they are paid, independent contractors have different tax responsibilities from wage or salaried workers. Wage and salaried employees, who receive W-2 forms from their employers at the end of every tax year, have their taxes taken out of their pay by their employers. It is the employer’s responsibility to pay the federal government taxes on their employee’s behalf.

Payments to independent contractors, on the other hand, are reported on Forms 1099. Businesses or individuals who hire an independent contractor for service are required to issue the contractor a Form 1099 on payments of $600 or more. Taxes are not withheld from payments made to independent contractors. It is the responsibility of the independent contractor to calculate and pay their own income taxes.

Filing Requirements

Every person or business that pays an independent contractor above $600 for work is required to file Form 1099 with the IRS; both the IRS and the independent contractor receive a copy of the 1099. Independent contractors should receive a Form 1099-MISC from each of their clients that pay them $600 or above during a tax year. Income received from each job/client will need to be included in Form 1099-MISC and you will be required to pay income tax on it.

Income from selling art works, freelance writings, consultancy, rents, prizes, awards, medical and health care payments, crop insurance proceeds, cash paid because of a partnership, fishing boat proceeds, etc,  are the types of income that need to be reported on Form 1099-MISC if they reach $600 or above.

If an employer has paid at least $10 in royalties or broker payments in place of dividends or tax-exempt interest, you will need to report the payments on Form 1099-MISC.

Reporting on Form 1040

Any non-employee compensation you receive as an independent contractor or self-employed individual will need to be reported on Schedule C of Form 1040. The self-employed, even if they are running a business can use Schedule C, Form 1040, to file taxes. Any activity where you are in control, that you regularly engage in to make a profit qualifies to be included in Schedule C, Form 1040.

You are required to pay the self-employment tax on your net earnings only if you earned $400 or more from self-employment activities. While W-2 employees fund their Social Security and Medicare trust funds by having taxes withheld from their income, the self-employed, on the other hand, fund their Social Security and Medicare funds by calculating and paying income tax themselves.

In some cases, estimated taxes need to be paid quarterly. Generally, if you are filing as a self-employed individual, sole proprietor, partner, or S-Corporation shareholder you should be paying estimated tax payments if you expect to owe $1,000 or more in taxes when you file your return. If you are filing as a corporation, you generally need to make estimated tax payments if you expect to owe $500 or more in taxes when you file its return. Form 1040-ES is used figure and pay estimated tax payments for those filing as a sole-proprietor, partner, S-Corporation shareholder or a self-employed individual. Corporations use Form 1120-W to file and pay estimated tax payments.  Non-payment of estimated taxes may lead to tax debt and IRS penalties.

From the author: Tax Resolution Legal Team
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