Starting your own business can be very rewarding, both personally and professionally, but it is also a LOT of work. You have to find a suitable space, get insurance, build a customer base and manage your finances. Among your financial responsibilities will be filing and paying your taxes, which can be tricky, especially as an independent contractor.
How does an independent contractor pay taxes?
Independent contractors are obligated to pay self-employment tax (SE tax) as well as income tax. SE tax is primarily Social Security and Medicare tax, similar to those withheld from the pay of most waged employees. You are expected to pay estimated tax quarterly and then file an annual tax return.
The IRS provides the handy Form 1040-ES to help you estimate the ES tax that you will pay quarterly. If it is your first year as an independent contractor, you will estimate your anticipated income; after that, you will pay quarterly taxes based on the previous year’s income. Adjustments can be made quarterly. These taxes can be paid online.
You do not have to file an annual tax return if your net earnings are less than $400. You determine this by subtracting your business expenses from your earnings. If you made less than $400 or lost money from your business during the year, you typically don’t have to file a tax return. You may still be required to file the form if you meet any other requirements listed in the Form 1040 instructions. You can file your taxes using a IRS forms Schedule C or Schedule C-EZ. These instructions can help.
If you made or received a payment, you are most likely required to file a Form 1099 with your annual return.
What is a form 1099?
A Form 1099 is what is called an “information return” by the IRS. An information return is a required report to the IRS on certain transactions, such as wages and other forms of compensation to employees, non-wage income, interest received, cancelled debt, etc. Basically, the IRS uses these forms to match data against tax returns and ensure that you are giving them their due.
There are sixteen types of Form 1099s, but let’s go over the few most relevant Form 1099s for independent contractors.
- 1099-MISC: The most common version of this form and the one you will almost certainly encounter, as it is used to report your income as an independent contractor.
- 1099-INT: This form is used to report any income over $10 from interest, like that from a savings account.
- 1099-DIV: This 1099 is for the reporting of dividends and distributions from investments.
- 1099-C: This form is for the reporting of cancelled debt. Cancelled debt is treated by the IRS as income and is taxable, so it must be reported.
Where do you get a 1099?
The good news is that, as the payee, it will be sent to you. Anyone who paid you more than $600 for a job or jobs during the year is required to file a form 1099 with the IRS and send you a copy by the end of January. The form will largely be empty, since most of the fields don’t apply to you. Typically, the form will only include your tax information and that of the payer and field 7 of form 1099-MISC, for non-employee compensation.
In order to receive this form, you should ensure that you complete a form W-9 before beginning any job. A W-9 is a request by the employer to receive your name, address and taxpayer identification information. They need this information in order to complete and file the 1099.
If you don’t receive a Form 1099 from a client from whom you expected to receive it, don’t stress. While you can reach out to the payer and request the form, this could create duplicates and actually cause more issues. You’re better off keeping your own records throughout the year and filing all your income, regardless of any Form 1099. The onus is on the payer to file the form 1099, but you can report income without it, and you should.
What do you do with a Form 1099?
In principle, a Form 1099 is to help you figure out how much income your earned in a given year. Ideally, a responsible business owner should keep his or her own records and be able to file an annual tax return without receiving any Form 1099s. In reality, things can get lost in the course of a year, so getting 1099s can fill in the gaps.
Keep in mind that you will only receive a 1099 from clients that paid you at least $600 throughout the year. You’re still required to report all your income, regardless of the 1099. When completing your annual return, you must include all of your 1099s and list your total income, whether or not it’s all listed on a 1099.
If you receive a Form 1099 from a client and think the information is inaccurate, address it with them immediately. If you can’t convince them, you can always explain your stance to the IRS. For example, if a client claims they paid you $4,500 for a project, per your initial contract, but in the end, the project was cut short and you only received $3,200, then you can explain this on your tax return and provide receipts as evidence. The IRS can adjust your taxes accordingly.
Preparing a Form 1099
Some independent contractors may also hire subcontractors and therefore be required to send Form 1099s at the end of the year. A few basics to keep in mind:
- File a 1099 for any independent subcontractors and unincorporated businesses to whom you paid at least $600 during the year.
- Do not file a 1099 for employees. Employee wages and non-wage compensation are reported on a Form W-2.
- Do not file a 1099 for corporations. You’ll be able to see a business’s classification on the Form W-9 that you should have requested from them when you hired them.
Having anyone who works for you fill out a W-9 is critical to ensuring that you complete all tax obligations. Without the W-9, you will have to track down the Taxpayer Identification Number and other information after the fact. If you can’t get this information, then you can’t file you W-2s and 1099s and you will be penalized by the IRS as a result.
You can get up-to-date Form 1099 instructions from the IRS website. You’ll fill out the form using the information you have from the W-9. Mostly, you’ll only need to fill in section 7: non-employee compensation, but always be sure to review the form and include any other relevant information.
Submitting a Form 1099
You can file 1099s by mail or electronically. Regardless, you must send your subcontractor Copy B of the form; if you want to send it to them electronically, you must get their consent first. Check the specific rules the IRS has for how you must obtain consent to send a 1099 electronically.
To file with the IRS electronically, you will use their FIRE (Filing a Return Electronically) Feature. You can submit via any number of compatible accounting software programs to submit your forms directly. In order to do so, you’re need a Transmitted Control Code (TCC), which you can request with a Form 4419. Be sure to do so at least 30 days before the deadline. You’ll receive your TCC and can use it to set up your FIRE account.
If you choose to file by mail, you can get a printable Form 1099 on the IRS website. Take note that you can print only Copy B; a physical Copy A is available only from an IRS office.
You will need to send copy B to the subcontractor by January 31st, so that they can file their own taxes on time. You must send Copy A to the IRS by the end of February, if you’re filing by mail, or March 31st if you’re filing electronically. If you’re submitting a physical copy of the 1099 to the IRS, you must also submit a Form 1096, which tracks every 1099 that you are filing for that particular tax year. The deadline for Form 1096 is the same as the deadline for 1099s. Be sure to check with the IRS to confirm the relevant deadlines for that year.
The IRS is serious business…
If you file late, you will be penalized. If you fail to file, you will be penalized. Penalties are assessed on each Form 1099 that is late or missing and they can add up.
Remember that whether you are the payer or payee, the IRS has ways of finding out what you paid or made. Be honest, be thorough and you’ll be ok. If you’re unsure or it’s your first year filing taxes as an independent contractor, you might want to consider hiring a professional.