Basic Taxation for the Independent Contractor

An independent contractor is considered a self employed individual, and income earned by an independent contractor is considered self-employment income. "Self-employment income is income that arises from the performance of personal services, but which cannot be classified as wages because an employer-employee relationship does not exist between the payer and the payee" (Self-Employment Tax).

Self-Employment Tax

Independent contractors are responsible for paying both income tax and self-employment tax. Income tax is paid on the income earned from performing the independent contractor services. Self-employment tax is social security and Medicare taxes. The self-employment tax rate for 2006 is 15.3% which is broken down into two parts: 12.4% for Social Security and 2.9% for Medicare. Self-employment tax is only applied to "the first $94,200 of...combined wages, tips, and net earnings in 2006" (Self-Employment Tax).

Self-employed individuals who do not have taxes withheld must make estimated tax payments, which are due quarterly. Estimated tax is determined by figuring "expected adjusted gross income, taxable income, taxes, deductions, and credits for the year" (Estimated Taxes).

Forms used to Report Income

Corporations, individuals, partnerships, estates, and trusts must use Form 1099-MISC to report income to the independent contractor and the IRS. Amounts of $600 or more paid to independent contractors during the year must be reported (A Guide to Information Returns).

Independent contractors report self-employment income on Form 1040, Schedule C, Profit or Loss from Business or on Form 1040, Schedule C-EZ, Net Profit from Business. Social Security and Medicare taxes are reported on Form 1040, Schedule SE, Self Employment Tax.

Expenses that can be Deducted from Income

Some expenses that can be deducted from income include:

- Half of self-employment tax may be deducted in figuring AGI - only affects income tax (Self-Employment Tax).

- Business use of a personal home

- Business use of a personal car

- Business supplies

Independent Contractor versus Employee: Which is Better?

It is not a simple question to answer whether it is better to work as an independent contractor or as an employee. Both have advantages and disadvantages, and it really depends on individual preferences. A few of the advantages and disadvantages are outlined below.

Advantages to working as an independent contractor include: you are your own boss, you may be paid more than employees, no federal or state tax is withheld from your pay, and you can take increased business deductions. Disadvantages to working as an independent contractor include: you have no job security, you must pay self-employment taxes, you may be personally liable for business debts and torts, and you have no employer-provided benefits.

Advantages to working as an employee include: you only pay half of social security and Medicare taxes, your employer may provide benefits, there is no need to estimate taxes, and you work regular hours. Disadvantages to working as an employee include: you may be paid less than an independent contractor, you have limited or no business deductions, you must work for someone else, and you have little or no control over your work schedule.

References

"Self-Employment Tax." IRS website. URL: http://www.irs.gov/businesses/small/international/article/0,,id=105255,00.html

"Estimated Taxes." IRS website. URL: http://www.irs.gov/businesses/small/article/0,,id=110413,00.html

"A Guide to Information Returns. IRS website. URL: http://www.irs.gov/efile/article/0,,id=98114,00.html