Nearly half the global workforce is self-employed. That means there’s a good chance you’ll work with an independent contractor at some point in your business career.
From a taxation perspective, independent contractors are self-employed, meaning they work with companies rather than for companies, and their taxes are their sole responsibility. However, in the United States, businesses that hire independent contractors must file certain tax forms to comply with IRS regulations and report payments to contractors.
Tax processes differ by country, however. In the United Kingdom, for example, independent contractors use a self-assessment tax return system to pay income tax and national insurance on earnings. They also must charge a value-added tax (VAT) when their income exceeds a specific threshold.
In this guide, we’ll explain independent contractor taxes, who pays them, and which forms you’ll need to file to comply with IRS regulations.
What are independent contractor taxes?
Everyone pays taxes, and independent contractors are no exception. In the United States, the two main categories of independent contractor taxes are:
- Income tax: Independent contractors have to pay income tax like any other worker. They may owe federal taxes, state taxes, and local taxes depending on how much net income they earn.
- Self-employment tax: Instead of payroll taxes paid by the employer, independent contractors contribute to Social Security and Medicare (also known as FICA taxes) by paying a self-employment tax. For the 2023 tax year, the self-employment tax rate is 15.3% (2.9% for Medicare and 12.4% for Social Security). This tax is calculated based on the independent contractor's net business income, which is their gross income minus any deductible business expenses.
Who pays independent contractor taxes?
When you hire an independent contractor, you’re not responsible for withholding and paying their taxes like you would be for a regular employee. Instead, the IRS considers independent contractors self-employed sole proprietors and requires them to determine and pay their own taxes. Independent contractors typically make quarterly estimated tax payments to cover their tax liabilities throughout the year, rather than having money withheld from each paycheck like employees.
As self-employed individuals, independent contractors may be eligible for various tax deductions to reduce their taxable self-employment income, such as the home office deduction for workspace expenses and the self-employment tax deduction. They can choose to itemize their deductions or take the standard deduction, depending on which option reduces their tax liability the most.
In rare cases, you may have to withhold taxes for the independent contractor if they report the wrong income on a tax return or provide the wrong Taxpayer Identification Number (TIN). This is called backup withholding. If this scenario arises, you’ll withhold a set percentage of future payments to the contractor and pay it directly to the IRS on their behalf. Backup withholding is not a common occurrence, but businesses should be aware of this requirement and comply with IRS regulations to avoid potential penalties.
While employers don’t handle taxes for independent contractors, ensuring you correctly classify workers as either employees or independent contractors is a must. Misclassifying an employee as an independent contractor can lead to severe consequences, including:
- Back taxes and penalties: Your business may be liable for the employee's unpaid income taxes and Social Security and Medicare taxes that should have been withheld. You may also face steep penalties and interest.
- Legal issues: Misclassified workers can file lawsuits against your company for benefits they should have received as employees, such as overtime pay, minimum wage, and workers' compensation.
- Reputational damage: Misclassification cases can generate negative publicity for your business, potentially harming your brand reputation and ability to attract top talent.
To determine whether a worker should be classified as an employee or independent contractor, the IRS evaluates several factors related to how much control and independence the worker has. These factors fall into three main categories:
- Behavioral control: Does your company specifically mandate how the worker performs their tasks? Employees typically receive detailed instructions and training, while contractors have more autonomy.
- Financial control: Does your company control the business aspects of the worker's job, such as providing tools and equipment, reimbursing expenses, and determining pay rates? Independent contractors usually handle such tasks themselves.
- Relationship: Is there a written contract outlining the worker's status? Do they receive employee benefits like health insurance and paid time off? Is the working relationship ongoing or project-based? Employees are more likely to have open-ended relationships with their employers.
What tax forms do you need to hire an independent contractor?
When your business hires an independent contractor, you'll need to collect and file three tax forms to ensure compliance with IRS regulations. These documents help establish the contractor's identity, clarify their tax obligations, and report the compensation you paid them throughout the year.
1. IRS Tax Form W-9, Request for Taxpayer Identification Number and Certification
The contractor should complete this form at the start of your working relationship. It provides their legal name, address, and Taxpayer Identification Number (TIN), which is either their Social Security number (SSN) or Employer Identification Number (EIN). You'll need this information for tax-reporting purposes.
2. IRS Tax Form 1099-NEC, Nonemployee Compensation
Your business is responsible for filling out Form 1099-NEC each year to report any payments of $600 or more to an independent contractor. It includes the contractor's personal information from the W-9 and the total amount you paid them during the tax year.
3. IRS Tax Form 1096, Annual Summary and Transmittal of U.S. Information Returns
Form 1096 serves as a cover sheet for all 1099 forms your business files for the year, including 1099-NEC forms. It summarizes the total number of 1099s you submit and the combined amount reported on those forms. Note that this form is not required if you e-file your 1099s.
If you have questions about these forms or your specific situation, consider consulting a tax professional for personalized guidance.
Independent contractor tax deadlines
The IRS requires independent contractors to estimate taxes and make quarterly tax payments if they expect to owe $1,000 or more for the year. These payments are due annually on April 15, June 15, September 15, and January 15.
As the contractee, you won’t have any tax obligations related to those deadlines. However, you'll need to complete and submit Form 1099-NEC by January 31 each year to report how much you paid your non-employees, including independent contractors, during the previous year. You'll also need to provide each contractor with a copy of the document.
Additionally, Form 1096, along with physical copies of the 1099s, must be submitted to the IRS by February 28 annually. Meeting these tax deadlines is necessary for both independent contractors and the businesses that hire them, as late or missed payments can result in penalties and interest charges.
To fill out a 1096, your business should collect a completed Form W-9 with each independent contractor’s legal name and TIN. It’s best to ask for this form as soon as possible so you have that information on record from the outset. The IRS recommends keeping a copy of the form for at least four years.
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