Some workers are “employees,” while others are considered “independent contractors.” While both receive compensation to perform labor or provide services, contractors and employees have very different filing responsibilities when tax time comes around. If you are an independent contractor, it is critical for you to understand the unique state and federal tax requirements that might affect you. Read on to learn more about federal and California tax requirements for independent contractors, and find out how the laws have recently changed. If you need help filing taxes as an independent contractor, ask Cook CPA Group for a free consultation about our tax preparation services in Roseville and Sacramento, CA.
Independent Contractors vs. Employees: What’s the Difference?
While both are paid to work, there are significant differences in the way employees and independent contractors are defined. In fact, as recently as April 2018, the California Supreme Court issued a major decision changing the long-held definitions. Before the ruling, employers could determine whether someone was an “independent contractor” by asking three questions:
- Did the company have financial control over the worker (e.g. reimbursement for expenses)?
- Did the company have behavioral control over the worker (e.g. control over equipment and tools)?
- What sort of relationship existed between the worker and the company (e.g. existence of written contracts)?
These rules, long used by the Internal Revenue Service (IRS), were sometimes criticized for being too vague. This could potentially make it easier for employers – hoping to avoid their payroll tax responsibilities – to intentionally misclassify employees as independent contractors.
California employers now use different criteria to define who is an independent contractor. The new set of criteria, or “ABC test,” is as follows:
- (A) Is the worker “free from the control and direction” of the company?
- (B) Does the worker perform labor “outside the usual course of the hiring entity’s business”?
- (C) Is the worker “engaged in an independently established trade, occupation, or business of the same nature as the work performed” for the company?
If the worker meets the ABC test, he or she should be classified as an independent contractor. But how does this classification affect the contractor’s state and federal tax requirements?
California and Federal Employment Taxes for Independent Contractors
If you aren’t sure whether you’re an independent contractor, you can file Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) with the IRS for assistance. Keep in mind, however, that it may take up to six months for the IRS to reply.
If you know you’re an independent contractor, the next step is fulfilling your state and federal tax responsibilities. If you earned more than $600, you should receive a document called Form 1099-MISC from the business entity by January 31. As a contractor, it’s your responsibility to complete Form W-9 (Request for Taxpayer Identification Number and Certification), which you should provide to the company that issued the form – not to the IRS.
As an independent contractor, you will also be responsible for meeting the IRS’ self-employment tax requirements. These requirements, which generally apply to independent contractors, sole proprietors, and members of partnerships, are that:
- You must file an annual income tax return (Form 1040). This requirement applies if you earned $400 or more through self-employment. To determine your net earnings from self-employment, you can use Schedule C (Profit or Loss from Business (Sole Proprietorship)) or, where appropriate, Schedule C-EZ (Net Profit from Business (Sole Proprietorship)).
- You must pay estimated taxes on a quarterly basis. Specifically, you are responsible for paying:
- Income tax
- Self-employment tax (SE tax)
As the IRS explains, the term “self-employment tax” generally refers to Medicare and Social Security taxes. When a worker is an employee, his or her employer normally withholds and matches these taxes. However, if the worker is an independent contractor, he or she must personally account for these taxes, hence the SE tax requirement. SE taxes are reported using Schedule SE (Self-Employment Tax), which should be attached to your income tax return. Note that the Social Security tax rate is currently 15.3% (2.9% for Medicare, plus 12.4% for Social Security).
In addition to meeting the federal tax requirements that are strictly enforced by the IRS, you will also need to meet state tax requirements. In California, the tax rules that affect independent contractors (who are called “service-providers”) are enforced by the Employment Development Department (EDD) and Franchise Tax Board (FTB). California Form 540-ES (Estimated Tax for Individuals), for example, must be filed to make estimated quarterly payments.
Keep in mind that, while there are numerous tax requirements for independent contractors, there can also be perks as well. Depending on your circumstances, you may be eligible to claim money-saving tax deductions, such as the home office deduction or self-employment tax deduction. The Sacramento tax accountants of Cook CPA Group can help you find the tax deductions you are entitled to claim as an independent contractor.
Tax Accountants for Independent Contractors in Roseville and Sacramento, CA
Complying with tax laws can be tricky, particularly if this is your first time operating a sole proprietorship or working as an independent contractor. If you are self-employed, make sure you have small business accounting support from a skilled and experienced tax professional.
Cook CPA Group works with independent contractors in all types of industries throughout the Sacramento and Roseville, CA areas. For a free consultation about taxes for independent contractors in California, contact our Sacramento CPA firm online, or call our law offices today at (916) 910-0323.