Independent contractors are responsible for paying their own taxes, including income tax and self-employment tax, which combines Social Security and Medicare taxes. Taxes are calculated based on net profit or loss and are due quarterly. Independent contractors are eligible for similar deductions as regular employees, plus some unique ones.
A person who is an employee of a business or corporation pays taxes when their employer deducts money from each paycheck before the employee receives it. An independent contractor, considered by the United States Internal Revenue Service (IRS) to be self-employed, is responsible for paying their own taxes to the IRS. These independent contractor taxes typically include income tax and a self-employment tax that combines Social Security and Medicare taxes. While these are basically the same taxes that standard employees pay, the method of payment is quite different.
Independent contractor taxes are calculated based on either a net loss number or a net profit number. These numbers are calculated by subtracting the total amount of business expenses a self-employed person had in a year from the total amount of money the business generated for the year. If expenses were greater than income, the difference is called a net loss. If the income was greater than the expenses, the difference is called the net profit. Income tax is paid based on net profit.
The self-employment tax takes a portion of the independent contractor’s income and includes it in the Social Security and Medicare programs. The fees for those programs are paid before a typical employee sees their paycheck. In a normal employer-employee situation, the employee would pay half of his Social Security and Medicare taxes owed and his employer would pay the other half. The IRS requires independent contractors to pay these two portions, making the tax exclusive to those who are self-employed.
Independent contractor taxes are generally due quarterly, rather than annually, as regular employment taxes are. This means that a self-employed person will make four separate tax payments to the IRS throughout the year, based on their estimated earnings at each point. If 90 percent of the total amount a person will owe for a year is not paid with the estimated final payment in January, the IRS can assess penalties in addition to collecting the rest of the money owed.
Independent contractor taxes are eligible for many of the same deductions that regular employees are eligible for, plus some unique ones. For example, independent contractors can deduct 100 percent of their health insurance costs for one year. This is because, in a regular employee-employer situation, the employer typically provides health insurance. Independent contractors can also deduct expenses for things like home offices and the gas needed to operate a vehicle used for a business.
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