There are various pros and cons of working as an independent contractor. One of the things you must understand from the start is that you’re responsible for managing your own taxes. In other words, there’s no employer to withhold federal, state, and local taxes.
Along the same lines, there are expenses you can write off as an independent contractor. Doing so reduces your tax liability, thus allowing you to keep more money in your pocket. Of course, with the IRS watching closely, you must make sure that you only deduct qualified expenses. You don’t want to make a mistake that could get you in hot water with federal or state tax authorities.
What taxes do independent contractors have to pay?
Before we dive into tax deductions as an independent contractor, let’s talk about the types of taxes that you have to pay. These include:
- Federal, state, and local income tax
- Self-employment tax (a combination of Medicare and Social Security taxes)
As noted above, it’s your responsibility to pay the self-employment tax. You don’t have an employer to withhold taxes and pay on your behalf, so you’re responsible for managing the entire process. This generally means making quarterly payments throughout the year.
What taxes can independent contractors deduct?
There’s no shortage of deductions for independent contractors. While you may not qualify for every deduction, it’s important to at least consider your options. You don’t want to miss out on something that could reduce your tax liability.
Here’s a list of the most common taxes independent contractors can deduct. There’s a good chance that several of these will pertain to you.
Self-employment tax deduction
You can claim 50 percent of what you pay in self-employment tax as an income tax deduction. For example, a $5,000 self-employment tax payment reduces taxable income by $2,500.
Here’s how the IRS explains the self-employment tax deduction:
You can deduct the employer-equivalent portion of your self-employment tax in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your self-employment tax.
Home office expenses
Most contractors work from home, which allows them to take a home office deduction. In addition to the space itself, there are direct expenses such as:
- Home repairs
- Office supplies
If you do any sort of traveling for your business, keep close track of your travel expenses so you can deduct them on your tax return. This includes mileage, airplane tickets, car rental, and hotel. Also, 50 percent of your meal costs can be written off as business expenses.
When deducting travel expenses, it’s important to keep close tabs on which ones are related to business and which ones aren’t.
Advertising and marketing costs
Any money you spend advertising or marketing your business can be written off. Maybe you generate business via online advertising. Or perhaps you run marketing campaigns to build your brand. Carefully track all these expenses.
Legal and accounting services
Legal and accounting services are critical to keeping your business safe and running at its peak. Example deductions in this category include:
- The cost of hiring a contract attorney, such as to review a non-compete agreement.
- The cost of consulting with a tax attorney.
- The cost of hiring a certified public accountant.
It’s never fun to spend money on legal and accounting services, but it’s often necessary.
Business internet and cell phone bill
Working from home means you’ll rely heavily on the internet and phone to communicate with prospects, customers, and suppliers among others.
Keep your business internet and cell phone bills separate from those that you use for personal reasons. This makes it easier to deduct the expense when tax season rolls around.
Here’s how the IRS defines depreciation:
You generally can't deduct in one year the entire cost of property you acquired, produced, or improved and placed in service for use either in your trade or business or income-producing activity if the property is a capital expenditure. Instead, you generally must depreciate such property. Depreciation is the recovery of the cost of the property over a number of years.
As a contractor, you can deduct a portion of the cost every year until you fully recover the total cost of your equipment.
Any insurance that you purchase for your business is deductible. Business insurance, such as a professional liability policy, is a common example.
You can also deduct 100 percent of medical, vision, and dental premiums.
Note: tax deductions vary for contractors around the world. So, if you don’t file taxes in the United States, these common deductions may not apply to you. Research the tax code in your country to find out more.
Does your company hire contractors?
If your company works with contractors, it’s critical to have a system in place for hiring, onboarding, and managing them.
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