Independent contractors, sometimes called freelancers or gig workers, can help businesses better control workforce costs and meet demands when workloads increase. To take full advantage of these benefits, however, employers must understand how to pay these individuals in accordance with payroll tax codes.
Who pays independent contractor taxes?
Independent contractors generally pay self-employment tax. So, although employers may not be responsible for withholding and depositing taxes for these individuals, they must be careful not to misclassify employees as independent contractors. The distinction between the two is not always clear and will depend on the unique circumstances in each case. Employers who need help with worker classification may wish to seek the advice of counsel and or refer to IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Independent contractor tax forms for employers
If an employer determines that someone performing services for them is an independent contractor, they will need the following forms:
Form W-9, Request for Taxpayer Identification Number and Certification
Independent contractors provide their legal name and taxpayer identification number (TIN) on Form W-9. The IRS recommends that businesses save this document for at least four years.
Form 1099-NEC, Nonemployee Compensation
Depending on how much employers pay independent contractors each year, they may have to report those payments using Form 1099-NEC. Filing this form isn’t always required if certain exemption criteria are met.
When to withhold independent contractor taxes
Because independent contractors pay self-employment tax, employers typically do not have to withhold taxes from their wages. There is, however, an exception known as backup withholding.
What is backup withholding?
Backup withholding is a tax deduction that occurs when independent contractors provide the wrong TIN or incorrectly report their income on a tax return. In this event, employers may be required to withhold a percentage of any future payments made to the contractor and deposit it directly with the IRS.
Deadlines for paying independent contractors
Terms of payment, including pay schedules, are usually an agreement between the employer and the independent contractor. However, Form 1099-NEC must be filed with the IRS and a copy provided to the contractor by specific deadlines.
Independent contractor taxes for the self-employed
Self-employed individuals might not have taxes automatically withheld from their paycheck as they would if they had an employer, but that doesn’t necessarily mean they are off the hook. In most cases, they’re required to pay taxes and file an annual return.
What taxes do independent contractors have to pay?
Independent contractors generally must pay income tax and self-employment tax, which is a combination of Medicare and Social Security taxes. Specific tax obligations will depend on whether the business resulted in a net profit or a net loss.
Should the self-employed pay quarterly estimated taxes?
The IRS typically requires independent contractors and sole proprietors to pay estimated taxes quarterly using Form 1040-ES, Estimated Tax for Individuals. This “pay-as-you-go” approach helps them avoid a large tax bill at the end of the year.
Can independent contractors deduct business expenses?
Depending on the circumstances, self-employed individuals may be able to deduct certain business expenses from their taxable income as an independent contractor. These include:
- The employer-equivalent portion of the self-employment tax
- The cost of health insurance
- Home office expenses
How to run payroll as one employee
Running payroll is not usually necessary for independent contractors. They can typically draw income directly from their business profits and in most cases, there is no need to withhold taxes because they pay estimated quarterly taxes.
Frequently asked questions about independent contractor taxes
What is the tax form for an independent contractor?
There are generally two tax forms associated with independent contractors. Employers use Form 1099-NEC to report how much they pay to non-employees each year and independent contractors use Form 1040-ES to estimate and pay their quarterly taxes.
What percent do independent contractors pay in taxes?
The self-employment tax rate is 15.3%, of which 12.4% goes to Social Security and 2.9% goes to Medicare. Income tax obligations vary based on net business profits and losses, among other factors.
Can I withhold taxes for an independent contractor?
In most cases, businesses do not withhold taxes from any payments to an independent contractor. If, however, backup withholding applies, employers may be required to deduct a portion of the individual’s earnings and send it to the IRS directly.
Do you pay more in taxes as an independent contractor?
Independent contractors generally pay both the employer and employee portion of Medicare and Social Security taxes. This is known as self-employment tax. In some cases, they may be able to deduct the employer-equivalent portion of the tax on their annual return.
Can an independent contractor be paid a salary?
Independent contractors are typically paid hourly or by the job. Details such as these may be outlined in the payment agreement between the employer and the contractor.
How are taxes calculated for independent contractors?
To calculate their quarterly taxes, independent contractors must estimate their adjusted gross income, taxable income, taxes, deductions and credits. It’s often helpful to use the previous year’s federal tax return as a guide.
This article is intended to be used as a starting point in analyzing independent contractor taxes and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.