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Taxes and the independent contractor
Dear Small Biz Adviser:
This year, I will be working as an independent contractor, and expect
to earn an average of $1,000 a month. It will be my responsibility
to file income tax. What form do I use to file, and would it better
to file quarterly? Thank you.
Kathleen
Dear Kathleen:
Welcome to the world of entrepreneurship. You are wise to consider
your tax responsibilities early in your self-employed career. However,
before addressing your specific tax-filing questions, let me briefly
cover a series of issues that could help you reduce or eliminate
any surprises at the end of the tax year.
An excellent starting point is the small
business section of the Internal Revenue Service Web site. It
will lead you to many relevant sources of information as an independent
contractor. Once there, check out:
- Business
structures: Your choice will significantly impact the types
and amounts of taxes you pay, even as an independent contractor.
- Employer
identification number: If you have no other employees and
do not list yourself as a paid employee, your Social Security
number will suffice for tax identification. Otherwise, you will
need an EIN.
- Independent
contractor requirements: Be certain you understand the difference
between a contractor and an employee. The information found here
will help you fulfill all tax requirements.
- Record
keeping: As you start your new business, pay particular attention
to the documentation needed to substantiate your venture's tax
deductions.
These are basic issues worth knowing from the outset.
Now let's move on to your greatest concerns: income and self-employment
taxes.
Picking the proper form
If you are operating as a proprietor, then simply file Schedule
C with whatever version of Form 1040 you use for your personal
returns. If your independent contracting business is incorporated,
then you will file Form
1120 or 1120S
for a C or S corporation, respectively. The IRS has instructions
that clarify filing for the Schedule
C, C
and S
corporations.
Maximizing business deductions
Pay close attention to IRS
Publication 535, Business Expenses, for help in identifying
accepted business expenses. If your house is the primary location
from which you will operate the business, review IRS
Publication 587, Business Use of the Home, for expenses
here that can be deducted from your gross income. Many people fail
to review this document and miss out on deductions.
Self-employment taxes
Self-employment taxes are often disregarded or overlooked out of
ignorance by many entrepreneurs during the startup phase. It's
only in that first tax season that many learn of their omission.
Begin by reviewing IRS
Publication 533, Self-Employment Tax. You will be expected
to make a total contribution equal to 15.3 percent of your net income
on a quarterly basis to cover Social Security and Medicare contributions.
Payment is to be made with Form
941. This is a complicated form, so read the form and its instructions
carefully to avoid any mistakes in your calculations.
You may not have a self-employment tax liability if
you are employed elsewhere while also operating as an independent
contractor. In such a case, part or all of any tax refund from a
personal-income filing related to your wage income will be redirected
to cover any shortfall of self-employment taxes. It is a common
occurrence.
Finally, order the Small
Business Resource Guide, a CD-ROM that the IRS released at the
end of February. It is free and contains valuable information regarding
taxes, forms, publications, instructions and other startup information.
Other goodies on the CD include information from government, nonprofit
and educational institutions.
This information should get you going in the right
direction. I wish you well.
-- Updated: Aug. 8, 2003
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