What are the Tax Implications for an Independent Contractor?
Unlike employees, independent contractors are required to pay their own income taxes and self-employment taxes. Self-employment taxes include Social Security and Medicare taxes. The current rate of self-employment taxes is 15.3% of the independent contractor's wages, with 12.4% of that rate going towards Social Security and 2.9% going towards Medicare.
Generally, independent contractors should keep back one third of their income to pay these taxes. However, the required withholding could be more or less depending on the individual financial circumstances of the contractor. The IRS provides a worksheet to determine the amount of withholding (IRS Schedule SE Form 1040) for the self-employment tax. Individuals also should speak with an experienced tax professional to determine the amount of the withholding.
Independent contractors are required to make estimated tax payments on any income that is not subject to withholding. Individuals who work only part time as independent contractors must pay self-employment taxes on those wages, even if they hold full-time jobs with employers who withhold taxes from their paychecks. Estimated tax payments are made quarterly with specific due dates set by the IRS. Payments not received by the due date may be subject to interest and penalties at the end of the tax year.
The IRS uses a specific formula to determine whether an individual is an independent contractor or an employee. If an individual is an employee, then he or she is not responsible for paying self-employment taxes or making estimated tax payments. Employers who misclassify their employees as independent contractors can be required to pay back all of the withholdings that were not paid for the employee. In the most egregious of cases, employers may face criminal charges.
The key question in the independent contractor vs. employee determination is the degree of control and independence the individual has vis-à-vis the employer. The IRS considers three factors in making this determination:
- Behavioral Control - Who controls what the individual does and how the individual does it? Does the employer provide specific directions to the individual? Does the employer provide training? Does the employer control how the work will be done? Is the individual allowed to hire assistants and others to complete the work?
- Financial Control - Who controls the business aspects of the employment? Does the employer reimburse the individual for business expenses? Does the employer provide supplies to the individual? Work space? Can the individual realize a profit or loss?
- Relationship - What type of relationship exists between the individual and the employer? Is there a written contract? Does the employer provide benefits to the individual? Does the work relationship have a specific term or is it ongoing? Is the work completed by the individual a key aspect of the employer's business?
All of these factors should be considered by employers in determining how to classify workers. If employers or independent contractors are unsure of how their employment relationship should be properly classified, either party can request the IRS make a determination for them by submitting Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding).
For tax purposes and to avoid penalties, it is important that an individual is correctly classified as an independent contractor or an employee. For more information on making this determination, calculating self-employment taxes or other employment law questions, contact an experienced attorney in your area.
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