Who is an Independent Contractor?
An independent contractor is a person or entity contracted to perform work or provide services to another entity as a non-employee. As a result, independent contractors must pay their own Social Security and Medicare taxes. The payer must correctly classify each payee as either an independent contractor or an employee. Another suitable term for an independent contractor is a freelancer.
BREAKING DOWN Independent Contractor
Doctors, dentists, veterinarians, lawyers, and many other professionals who provide independent services are classified as independent contractors by the Internal Revenue Service (IRS)¹. However, the category also includes contractors, subcontractors, freelance writers, auctioneers, and many others who provide independent services to the general public.
In more similar definition, if the employer is not controlling when, where or how work is done, then the worker is considered an independent contractor.
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.
Tax Responsibilities of the IRS Form 1099 Contractor
The IRS Form 1099 is used to report a variety of unique income payments to the IRS. This form is usually used when the taxpayer has received income from other sources besides a wage-paying job.
Payments to independent contractors 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.
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.
Reporting on Form 1040
According to the IRS, you use this schedule to report income or loss from a business you operated or a profession you practiced as a sole proprietor.
An activity qualifies as a business if:
• your primary purpose for engaging in the activity is for income or profit, and
you are involved in the activity with continuity and regularity.
Any non-employee compensation you receive as an independent contractor or self-employed individual will need to be reported on 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.
¹IRS: The Internal Revenue Service (IRS) is a U.S. government agency responsible for the collection of taxes and enforcement of tax laws. Established in 1862 by President Abraham Lincoln, the agency operates under the authority of the United States Department of the Treasury, and its primary purpose includes the collection of individual income taxes and employment taxes. The IRS also handles corporate, gift, excise and estate taxes. People colloquially refer to the IRS as the “tax man.”)