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Paying Contract Labor Taxes: A Self-Employed Guide

Navigating contract labor taxes when working for yourself can be daunting. Contract laborers, also called self-employed individuals, have to pay both income taxes and self-employment taxes as they aren’t regular employees. Whether you're a freelancer, independent contractor, or running your own small business, understanding how to manage your tax obligations is essential for your financial stability and compliance with the Internal Revenue Service (IRS). Unlike W-2 employees, contract laborers can use 1099 tax write-offs to lower SE tax. These business deductions are an important asset to self-employed individuals as it is the biggest way to reduce taxable income.

Table of contents

Key takeaways...Read more

What is contract labor?...Read more

Independent contractors vs W-2 employees...Read more

How to pay independent contractors as a business owner...Read more

Paying taxes as an independent contractor...Read more

Income taxes...Read more

Self-employment taxes...Read more

Estimated taxes...Read more

What can you write off as a 1099 contractor?...Read more

Key takeaways

Self-employed individuals have to pay contract labor taxes.
Business tax write-offs can lower 1099 taxes.
Contract laborers might have to pay estimated quarterly taxes if their tax liability is over $1,000.

What is contract labor?

The contract labor definition varies, but it essentially boils down to “any individual hired to complete a specific job and is not treated as a full-time employee.” In the US, contract laborers can be anyone from Uber drivers to freelance models. If you’re unsure whether you’ve been hired for contract labor, the IRS has three rules that classify someone as an independent contractor.

Infographic entitled IRS Common Law Rules listing questions determining contract labor classification.

Independent contractors vs W-2 employees

It’s important to make sure you’re correctly classified before you file your taxes. Any misclassification can potentially lead to fines from the IRS. So, if you’re unsure, it’s a good idea to bring it up with your clients. When businesses wrongly categorize an employee as an independent contractor, they can face penalties from the IRS, federal agencies and state and local jurisdictions, too. Additionally, these businesses might be required to compensate the misclassified workers for any overtime wages they should have received when they were incorrectly identified as independent contractors. So what’s the difference between the two? Independent contractors are essentially self-employed individuals or businesses hired on a temporary or project-specific basis. Their work arrangements are typically less structured and formal compared to W-2 employees. If you’re hired for contract labor, you have a higher degree of flexibility in terms of your work schedule and the ability to take on multiple clients. You can also write off business expenses as independent contractor tax deductions and lower your taxes. On the other hand, W2 employees are usually engaged in ongoing, long-term employment relationships with employers. Their work schedules are typically defined by their employer, and they work under more structured conditions. Their company withholds their taxes, and they are offered benefits like retirement contributions, annual leave and health insurance.

How to pay independent contractors as a business owner

Say you hired a freelance social media manager to help you grow your business’s online presence. If they earn over $600 in a year over the course of their contract, you will need to send them a 1099 form. 1099 forms can be of many types, but Form 1099-NEC (Non-Employee Compensation) is the most common. You’ll need to send your contractor this form by the end of January and send the IRS a copy. Another form you’ll need as a business owner when dealing with independent contractors is Form W-9. It contains your contractor’s tax information and essentially lets the IRS know you’ve hired a 1099 worker. You also don’t need to withhold pay from independent contractors since they’re responsible for paying their own taxes.

Infographic entitled Important Contractor Forms For Business Owners describing two forms used for paying independent contractors.

Paying taxes as an independent contractor

As independent contractors are considered self-employed, they must manage their own tax obligations. This means setting some money aside for income tax, and paying self-employment taxes. Independent contractors often have to make estimated tax payments quarterly to avoid a large tax bill at the end of the year.

Income taxes

Income taxes include federal, state and local taxes. However, not all states collect personal taxes, so make sure you do your research. Your taxable income and tax bracket determine how much you’ll pay in income tax. But first you’ll need to calculate your AGI (Adjusted Gross Income). To find your AGI, all you have to do is subtract your income adjustments from your gross income. Adjustments to income have to be reported on Schedule 1 and include:

Health insurance premiums
Retirement contributions
7.65% of SE tax
Student loan interest

Every taxpayer can choose between the standard or itemized deduction to lower their AGI. The standard deduction is updated every year and is dependent on your filing status (single, married filing jointly, married filing separately or head of household). The itemized deduction (reported on Schedule A) involves deducting eligible personal expenses from your taxes. Personal itemized expenses include:

Dental costs
Medical costs
Charity contributions
Home mortgage interest
State and local taxes

You should only take the itemized deduction if you have a lot of personal expenses that exceed the standard deduction. You can find your taxable income by subtracting the standard or itemized deduction from your AGI. Once you have your taxable income, you will pay income taxes as determined by your filing status and tax bracket. For 2023, the tax brackets are: 10%, 12%, 22%, 24%, 32%, 35% and 37%. The filing deadline for income taxes is usually April 15. Form 1040 is the main form that you’ll need to fill out. You can file for an extension until mid-October, but you’ll still have to pay your taxes on time.

Self-employment taxes

When you work for an employer, both you and your employer are jointly responsible for contributing to Social Security and Medicare taxes. This includes a 6.2% Social Security tax on the first $160,200 of your income and an additional 1.45% Medicare tax on your entire income. If you are self-employed, you bear the entire tax burden yourself. This means paying both the portion you would typically pay as an employee (7.65%) and the portion your employer would typically cover (7.65%). Paying 1099 contract taxes is quite complicated compared to income taxes. You need to pay 1099 tax if your earned income crosses $400. The self-employed tax rate is set at 15.3% of earned 1099 income. The self-employment tax comprises: 12.4% for Social Security and 2.9% for Medicare. High-income contract laborers may be subject to an additional 0.9% Medicare tax on income exceeding $200,000 for single filers or $250,000 for married couples filing jointly. However, you can use 1099 tax write-offs to lower contract labor taxes. You can use a self-employed tax calculator to easily calculate your owed tax. Or you can use FlyFin, which offers unlimited CPA support, in-built tax calculators, an A.I. that finds deductions and an income tracker. Schedule SE is where independent contractors will calculate owed self-employment tax. Business deductions should be recorded on Schedule C. Both these forms should be attached to Form 1040 and filed by April 15.

Estimated taxes

The U.S. tax system operates on a "pay-as-you-earn" basis, meaning taxes are collected as you receive your income. If you’re not a W-2 employees who gets their taxes withheld, it becomes your responsibility to make these tax payments throughout the year. Any income that isn't subject to automatic withholding by an employer is typically taxed on a quarterly basis. If you're self-employed, you'll need to think about making estimated tax payments if you expect your total tax bill to be over $1,000. This includes both income taxes and self-employment tax. To figure out this estimate, you can take a look at your past year's bank statements and 1099 forms or use an estimated tax calculator.

Infographic entitled Quarterly Tax Deadlines showing deadlines for making estimated tax payments for individuals involved in contract labor.

You should report estimated payments on Form 1040-ES. It’s essential that you make these payments on time and pay the right amount. Otherwise, you could be facing a lot of penalties from the IRS. The most common penalty is the one for underpayment. The underpayment penalty is something you'll want to avoid. To dodge this penalty, you should aim for two key things: timing and accuracy. First, make sure you pay your estimated taxes on time. Missing the deadlines can lead to accumulating interest and penalties. Second, it's crucial to get your tax estimates right. That means accurately predicting your income and deductions to avoid underestimating your tax liability. Remember, underpaid taxes trigger penalties and accrue interest, so it's in your best interest to pay what you owe correctly and promptly. Financial planning plays a big role, so keep meticulous records, understand your deductions and plan ahead. If you already have penalties to pay, you can use a tax penalty calculator to help.

What can you write off as a 1099 contractor?

When it comes to contract labor, taxes can be a bit tricky to navigate, but there's a bright side to it. You can use your business expenses as deductions to lower your self-employment (SE) tax. Here's how it works: As an independent contractor, you often incur various expenses related to your work, like office supplies, equipment, travel and advertising. The IRS allows you to deduct these expenses from your income. By taking advantage of these 1099 tax write-offs, you can reduce your taxable income, lowering the SE tax you owe. This can lead to meaningful savings when tax season rolls around. But it's important that you keep records of all your business-related expenses if you want to deduct these expenses. That means receipts, invoices, and any other documentation to prove that these deductions are legitimate. To make the most of these deductions and ensure you're on the right track, it's a good idea to chat with a tax pro who knows the ins and outs of self-employment taxes, like one of FlyFin’s CPAs. Say you’re an Uber driver, and wondering, “What expenses can I deduct as a 1099 contractor?”. Throughout the year, you’ve incurred various expenses that are ordinary and necessary to your work. You keep meticulous records of your vehicle expenses, including mileage and fuel costs. You know you can deduct a portion of these costs because they're essential for your business. By calculating your annual mileage and using the IRS 2023 standard mileage rate, you can claim a significant deduction for vehicle-related expenses. Additionally, since you rely on your phone for ride requests and navigation, you can deduct a portion of your cell phone bill as a business expense, too. You occasionally invest in cleaning and maintaining your car for passenger comfort and safety, and these expenses also qualify as ordinary business costs. Whenever you incur tolls and parking fees during rides, you can claim them as deductible expenses. Uber takes a commission from each fare, and so you can also deduct these fees as business expenses. The number of independent contractor tax deductions you can claim will vary based on your profession. A 1099 tax calculator is a good tool that can help you claim relevant deductions for your work.

Infographic entitled What Can I Deduct As A 1099 employee listing some independent contractor tax write-offs that can lower SE tax.

Contract labor can bring a lot of flexibility to your life. But your tax situation might get a little more complicated. So whether you mail in or e-file your returns, keep updated records and get help when you need it.

Office Supplies Tax Deduction

Office supplies are tax deductible for self-employed individuals and can be reported under the office expenses category on Schedule C.