Independent Contractor Taxes: A Guide for US Employers

Independent contractors are flexible in terms of hiring and termination. Unlike employees, you have minimum compliance requirements for independent contractors. 

However, you must comply with the applicable tax laws and labor regulations. 

You mustn’t be misinformed, especially when navigating remote work and taxes. Otherwise, it could lead to employee misclassification with significant legal, financial, and reputational consequences. 

This guide covers essential tax-related information for US employers managing independent contractors. 

It includes IRS guidelines on the independent contractor tax rate, tax forms, reporting requirements, and best practices.

What is Independent Contractor Tax?

The two main categories of independent contractor taxes in the US include: 

• Income taxes: Federal and state taxes on self-employed income 
• Self-employment taxes: This tax is equivalent to the Social Security and Medicare taxes paid by you and your employees (otherwise known as FICA taxes) 

The self-employment contractor tax rate in the US is 15.3%, which breaks down to 12.4% as Social Security tax and 2.9% as Medicare tax. 

There is an additional 0.9% Medicare Tax if the wages, compensation, or self-employment income exceeds the threshold amount: 

Who must pay independent contractor tax?

Independent contractors pay their taxes directly.

Moreover, independent contractor tax applies to those with net self-employment income: (Net self-employment income is the gross income from self-employment minus any deductions)

• Exceeding $400 (excluding income as a church employee)
• Earning $108.28 or more as a church employee

However, the exempted independent contractors may not be covered under free healthcare. 

How to calculate the independent contractor taxes

Your 1099 contractor can calculate their independent contractor taxes in the following ways: 

• They can file Schedule C and use Form 1040 to report self-employment income and expenses or Form 1040-ES in case of a sole proprietorship or partnership.
• They can use Schedule SE under Form 1040 to report self-employment tax.

Independent contractor deduction

Your independent contractor is responsible for paying the employer and employee portions of Social Security and Medicare taxes, combined into the self-employment tax. 

However, the IRS offers a deduction that can help offset this burden. 

The self-employment tax deduction allows them to deduct half of their self-employment tax as business expenses when calculating their adjusted gross income. 

This reduces the self-employment tax rate effectively from 15.3% to 7.65%.

Independent Contractor Tax Rates

Unlike employees, you need not withhold income taxes for independent contractors. 

Moreover, 1099 contractors, including freelancers or independent business owners, are liable to pay federal & state income taxes and self-employment taxes directly. 

Here's a breakdown of individual contractor tax rates: 

1) Federal and state tax rates

The federal income tax ranges between 10% to 37%, increasing progressively depending on the income level. 

The IRS determines tax brackets annually, which are then used to calculate the income tax owed. 

Moreover, state income tax rates and rules vary across the 50 states in the USA. Some states have no income or flat-rate tax, while the rest have progressive rates similar to the federal tax system.

2) States with no income tax

The following states do not impose any independent contractor tax on income:

• Alaska
• Florida
• Nevada
• South Dakota
• Tennessee
• Texas
• Wyoming

Washington and New Hampshire are set to join the no-income-tax state list by 2027. 

3) Flat-rate income tax states

The following states impose a flat-rate tax on income earned by independent contractors:

4) Graduated income tax states

Just like the federal income tax, most states follow a graduated income tax where the independent contractor tax rate increases as their income increases:

IRS Guidelines for Independent Contractor Taxes

You can avoid employee misclassification following the unique multi-factor test from the IRS: 

Employer control and behavioral control

Ask yourself the following questions to determine behavior control over the worker: 

• Instructions: Do you provide detailed instructions on how to perform the work?
• Training: Do you provide training or supervise ongoing work?
• Evaluation: Do you evaluate the worker's performance and provide feedback regularly?

Financial investment and relationship

Ask yourself the following questions to determine financial control and the nature of the relationship between you and your worker: 

• Investment: Do you invest in equipment or supplies needed for the work?
• Profit or loss: Does the worker have the potential for profit or loss?
• Expenses: Do you reimburse all business expenses?

• Written agreement: Is there a written agreement between you and your worker that specifies the worker's status?
• Duration: Is the work relationship for a specific project or period?
• Integration: Is the worker integrated into your business operations?

When classifying a worker's status as an independent contractor or an employee, all categories are considered in tandem without assigning a specific weight to any factor.

Recordkeeping & Reporting Requirements

You must maintain accurate records and file certain tax forms as part of contractor onboarding and contractor payroll. Here is the IRS-prescribed contractor tax guide:

Issuing form W-9 to US residents

• Form W-9 is an IRS-issued tax form to collect a taxpayer's identification number (TIN) from your US resident contractor. 
• You must download Form W-9 from the IRS website and ask the independent contractor you're working with to furnish the necessary details. 

Issuing form W-8 to foreign residents

• Form W-8 is an IRS-issued tax form to collect a taxpayer's identification number (TIN) from your foreign contractor. 
• Using the form W-8 can help you avoid over-withholding taxes by determining if the foreign contractor is covered under any U.S. tax treaty. 
• Further, if the foreign contractor is an individual, you must provide either Form W-8BEN (for benefits under a tax treaty) or Form W-8BEN-E (for exemption from U.S. tax withholding). 
• If the foreign person is an entity, you must provide Form W-8ECI (for income that is effectively connected with a U.S. trade or business) or Form W-8EXP (for income exempt from U.S. tax).

Issuing form 1099-NEC

• When you pay the contractor $600 or more during the tax year, you must report this payment on Form 1099-NEC. 
• This includes payments for services rendered, such as freelance work, consulting, or contract labor.
• You can use the TIN from form W-9 or W-8 to report the payment accurately.
• You must file Form 1099-NEC with the IRS by January 31st of the following year and provide a copy to the independent contractor.

Form 1099-K for payment settlement entities

• When you pay your contractors more than $20,000 in gross payments through credit cards, debit cards, or payment processors like PayPal or Stripe, your contractors will receive a copy of Form 1099-K reporting their income payments to the IRS.
• Form 1099-K is also issued if you made more than 200 transactions during the tax year using the payment processors with the same contractor.

Backup Withholding Rules

Backup withholding is an alternative mechanism for the IRS to collect taxes from those who fail to disclose their correct taxpayer identification number (TIN), including their Social Security number (SSN), Employer Identification Number (EIN), or individual taxpayer identification number (ITIN). 

If the contractor is subject to backup withholding, you must withhold a certain percentage of the payment and report this on Form 1099-NEC as part of compliance. 

How to Pay Self-Employment Tax

You can guide independent contractors in estimating their tax liability for the year and making quarterly payments to the IRS using Schedule SE under Form 1040-ES.

Contractors can estimate tax liabilities from self-employment income and any other sources and divide them into four parts. 

Further, they can make quarterly payments per the following deadlines: April 15, June 15, September 15, and January 15 of the following year.

Common Tax Deductions for Independent Contractors

Unlike employees, independent contractors can deduct the following expenses from their taxable income to reduce their tax liabilities:

Legal and Financial Risks of Misclassification

You must avoid deliberate employee misclassification for potential savings from reduced compliance burden. 

If the IRS determines that a worker should have been classified as an employee, you may face penalties and interest, including: 

• For misclassified workers, you may be required to pay income tax, Social Security tax, and Medicare tax.
• Moreover, the IRS may impose interest and penalties on unpaid taxes.
• You may face additional penalties when you violate wage and hour laws (such as minimum wage or overtime laws)
• Eventually, the Department of Labor (DOL) may investigate your employment practices and impose penalties if violations are found.

Manage Taxes for Independent Contractors with Skuad

Skuad provides an efficient contractor management solution. 

With Skuad, you can manage contractors from virtually anywhere, expanding your talent pool and accessing top talent.

Skuad provides expert guidance on classifying workers as independent contractors or employees, ensuring compliance and efficiency with labor laws in over 160+ countries. 

The platform simplifies contractor onboarding and handles contractor payroll, independent contractor taxes, and benefits in 100+ local currencies. 

‍Book a demo to understand the full potential of Skuad as your trusted contractor payroll and contractor management platform.

FAQs

1) What is the IRS tax rate for independent contractors?

The IRS contractor tax guide prescribes a progressive federal income tax between 10% and 37%. Independent contractors are also subject to self-employment tax at 15.3% of their income, split into 12.4% for Social Security and 2.9% for Medicare. 

2) How does a 1099 employee pay taxes?

Unlike regular employees, you are not required to withhold income taxes for your 1099 contractor workers. A 1099 employee is responsible for paying their taxes to the IRS directly, typically reporting through Form 1040-ES. 

3) Do independent contractors get tax refunds?

Yes, independent contractors are eligible for tax refunds. It usually happens when they overestimate their quarterly estimates on Form 1040-ES and receive proportionate refunds after filing annual tax returns. 

4) How to pay contractors?

Some of the common payment methods for paying international contractors are direct bank transfers, deposits, contractor payment platforms, digital wallets like Payoneer, PayPal, Wise, and cryptocurrency. You may also use an Agent-of-Record, like Skuad, for comprehensive contractor management services, which includes contractor payments.