Tax Implications of Being An Independent Consultant
Taxes are withheld and transmitted to the IRS on your behalf when you work for an employer, but not everyone is employed by someone else. Some prefer to work for themselves and provide their services and expertise in exchange for fees. These independent consultants don't have taxes withheld from what they're paid throughout the year. They're required to pay estimated taxes quarterly.
Your Employment Status
First, ensure that you meet the IRS requirements to qualify as an independent consultant or contractor. Generally, the entity you contract with can provide you with guidance on what they want you to do for them, but you determine how you do it. The IRS considers that you're an employee if the entity tells you what they want to have done and how it should be done.
You determine how much you're paid. Your client has the right to accept that or decline your services. You don't receive any type of employee benefits.
The entity you're conducting work for is required to withhold taxes and pay them for you if you're an employee, but you must pay estimated taxes quarterly if you're an independent contractor.
Making Quarterly Payments
You must make estimated quarterly tax payments if you're an independent contractor. Your estimated tax payments are due to IRS on the 15th of the month following each quarter's end. This means you'll have estimated taxes due for the 2021 tax year on:
- April 15, 2021
- July 15, 2021
- September 15, 2021
- January 15, 2022
You must file your annual tax return by April 15.
The IRS will consider it to be a quarterly payment for the fourth quarter of the current year if you decide to pay only once at the end of the tax year, but penalties can apply.
Filing Taxes as an Independent Consultant
You're a "sole proprietor" tax filer as an independent consultant, unless you've taken steps to establish yourself as another type of business entity. This would be the case if you've incorporated. Sole proprietors are required to report and file their business taxes with their personal income taxes.
This requires completing Schedule C to determine your net business income for the year. Schedule C lists all your revenue for the year, then it allows you to deduct reasonable and necessary business expenses to arrive at your taxable business income. This income is then reported on your personal Form 1040 tax return.
You'd also file your business taxes with your personal taxes on Schedule C if you've registered as a limited liability company (LLC).
You might be able to deduct a portion of the expenses of your home if you have a dedicated space in which you conduct business—a "home office." You must use this space exclusively for business purposes. Any personal use of the area disqualifies it as a business tax deduction, and it must be the primary location of your business. You run things from there, even if you visit clients elsewhere.
Office supplies or equipment can be deducted on Schedule C as well, along with a percentage of vehicle costs for miles dedicated to business, a percentage of utilities, and other business-related expenses.
If You Work Another Job
You can usually have your employer withhold additional taxes from your paychecks to cover your consulting income if you work for someone and consult on the side. Your spouse could also request additional withholding from their pay if they're employed, you're married, and you're going to file a joint return.
You can combine any of these methods as long as the IRS receives regular payments.
The Self-Employment Tax
You must pay Social Security and Medicare taxes as an independent consultant, in addition to income tax. These represent the self-employment tax. Normally, your employer would pay half and you would pay half, but you must pay 100% if you're not employed.
The Social Security tax is 12.4% of your net earnings, up to the year's wage base, which is adjusted annually for inflation. The wage base is $142,800 for tax year 2021. You can stop paying into Social Security for the year until January of 2022 when and if you hit this threshold. Medicare is taxed at a rate of 2.9% of your net income as of 2021. There's no wage base for this tax.
You don't have to pay unemployment taxes if you're self-employed unless you hire employees. You would then have to pay it on their behalf. You aren’t personally eligible for unemployment or disability as a sole proprietor unless you voluntarily pay into these programs.
IRS. "Independent Contractor (Self-Employed) or Employee?" Accessed Nov. 14, 2020.
IRS. "Top Frequently Asked Questions for Estimated Tax." Accessed Nov. 14, 2020.
IRS. "Schedule C & Schedule SE 1." Accessed Nov. 14, 2020.
IRS. "Home Office Deduction." Accessed Nov. 15, 2020.
Social Security Administration. "Contribution And Benefit Base." Accessed Nov. 14, 2020.