How to determine if you are an independent contract worker and what to do if you are
Many employers today utilize the service of contracted personnel instead of hiring on actual employees. This has advantages for both the employer and the worker as well as disadvantages. Typically what is an advantage to the employer is a disadvantage to the worker and vice versa.
From the employer’s perspective, bringing in an independent contractor saves money. The employer simply writes a check to pay the worker. There is no payroll, no employment taxes, no withholding etc. The downside for the worker? They are responsible for 100% of the taxes.
However, in order for an employer to classify someone as a contract worker, there are a few rules. One of the key rules is whether the employer controls the work and hours of the worker. If the individual is given set hours, a set task with established guidelines on how to perform the task and the employer provides the tools, the individual is likely an employee (if this applies to you and you are being paid as a contractor, please contact an expert in labor law to determine if your employer is illegally classifying you as a contractor). However, if you are given a specified task and you have agreed on a timeline or deadline, but you provide the tools and decide your hours, you may be considered an independent contractor.
Okay, I’m an independent contractor. What does that mean for me?
As an independent contractor, you are effectively self-employed. This means you are responsible for paying 100% of the employment taxes (often referred to as quarterly payments or just quarterlies). Being self-employed also requires you to keep accurate records of income and expenses. This can be done in a notebook, a spreadsheet, an accounting program or even a shoebox (if you have a patient bookkeeper). You are required by the IRS to report all income and expenses. Each quarter, you should be submitting to the IRS, at a minimum, a payment of 15.3% of your net income. This is your self-employment tax. It is also advisable to submit a percentage equal to your effective tax rate for the previous year (your tax liability after credits/your net income. On a Form 1040, this would be line 63/line 38).
Example, last year, your line 38 adjusted gross income was $48,000. Your line 63 total tax was $4,000. Your effective tax rate would be 8.3% (4000/48000).
If you have $10,000 in net income for the quarter (net income = income –expenses), you would need to submit $1,530 for self-employment plus an additional 8.3%, or $830, for a total quarterly payment $2,360.