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Steve Windhaus Ask the Small Biz Adviser

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.

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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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See Also
How to make self-employment less taxing
5 steps to startup success

Health insurance for the entrepreneur

Avoiding startup sticker shock
More Small Biz stories

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