Beginner’s Guide to Taxes as a Contractor

Updated May 2024

So you’ve made the leap from employee to an independent contractor. Along with this exciting career move comes the opportunity to work on new projects, set your own hours, and become your own boss. But one terrifying aspect awaits: taxes. Just the mention of these two syllables can leave many beginner contractors panicking. But with a bit of planning and some handy tips, you can turn the struggle of taxes as a contractor into part of your normal business operations.

In the past, your employer took care of your taxes. Medicare, Social Security, and FICA were all subtracted from your pay, taking all the math and worry out of the equation. Now that you’re a contractor, you’re left to fend for yourself. If you underpay, Uncle Sam and the Internal Revenue Service (IRS) will come knocking. Overpay, and you’re giving the government an interest-free loan. That’s why we’ve compiled a list of everything you need to navigate the hazy waters of taxes as a contractor. With any luck, you’ll quickly become a tax pro.

Do I Need to File Taxes as a Contractor?

You always need to file taxes as a contractor.

If you’re a new contractor, you may hear conjecture and other misinformation about filing your taxes. To many self-employed individuals, finding ways to skimp on taxes is a rite of passage. However, you should take these ideas lightly. Regardless of how much you make as an independent contractor, you must file taxes. The good news is that the government won’t place a self-employment tax on your income if you earned $400 or less in a given tax year.

When Do I Need to Pay Taxes as a Contractor?

You should pay taxes quarterly.

Unlike an employee, your taxes aren’t deducted each week. As a result, you can fall behind quickly on your taxes as a contractor. Unfortunately, federal, state, and local governments don’t like to wait for their money. Thus, they can legally impose penalties, interest, and late fees on your taxes if you don’t pay the right amount (within 90% of what you owe) every quarter.

In a year without any incidents (such as a pandemic or natural disaster), you should pay your quarterly taxes on the following dates:

First Quarter (Q1) – April 15
Second Quarter (Q2) – June 15
Third Quarter (Q3) – September 15
Fourth Quarter (Q4) – January 15

Failure to adhere to these requirements may result in sizable penalties from the IRS, as well as the state or local department of revenue.

How to Calculate Taxes as a Contractor

One of the most problematic aspects of taxes as a contractor is trying to figure out what you owe. Yet it’s not as difficult as you may think if you break it down. Here’s what you owe:

Income Tax
Self-Employment Tax

That’s it. That’s all you have to pay. Nevertheless, calculating the numbers and finding deductions makes the process a bit more mind-numbing.

Income Tax

Calculating your income tax is based on a tiered tax bracket. In most cases, your clients will send you 1099-MISC forms that show how much you earned from them. As you earn more money, the IRS takes a larger chunk of your income. The 2024 tax rates are:

• $11,600 or less – 10%
• $11,601 to $47,150 – 12%
• $47,151 to $100,525 – 22%
• $100,526 to $191,950 – 24%
• $191,951 to $243,725 – 32%
• $243,726 to $609,350 – 35%
• $609,351 and up – 37%

State and local taxes vary, but these types of taxes are either tiered or flat. If you’re lucky enough to live in one of these seven states, you won’t have to pay any income tax at all:

• Alaska
• Florida
• Nevada
• New Hampshire (doesn’t tax earned wages, but does tax investment earnings)
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

Because of the lack of income taxes and affordable incorporation fees, some contractors and online businesses choose to incorporate in one of these states. But beginners shouldn’t worry about this until later on.

Self-Employment Tax

If you’ve ever looked at a paycheck from when you were an employee, you’ll notice that your employer takes out money for Medicare and Social Security. Known as the Federal Insurance Contributions Act tax, or FICA tax, this mandatory deduction takes a total of 7.65% from your check, including 6.2% for social security and 1.45% for Medicare. Your employer matches this amount and pays 7.65% in FICA taxes on their own.

But this is where matters get tricky for contractors. As a contractor, the government sees you as both an employer and an employee. This translates to a total tax of 15.3% (7.65% multiplied by 2), also known as self-employment tax. Every self-employed person, freelancer, and contractor has to pay this 15.3% on top of their income tax, which results in a sizable tax bill each quarter. However, you can use deductions to lower this overall bill so it’s not as overwhelming.

Taxes as a Digital Nomad

If you’re a contractor who’s also a digital nomad, taxes may seem a bit trickier. But no matter where you are in the world, you pay taxes just as you would if you were based in the United States. That means you should pay quarterly taxes to the federal, state, and local (if necessary) governments, as required by law.

However, digital nomads can take advantage of a great program to eliminate most, if not all, of their tax liability.

The Foreign Earned Income Exclusion

U.S. citizens (including contractors and digital nomads) can take advantage of the foreign earned income exclusion, or FEIE. The FEIE allows eligible contractors to exclude a portion of their income tax, provided that they meet certain requirements. While there are three ways a person can become eligible for the FEIE, we’ll focus on the most probable scenario for contractors: the physical presence test.

The physical presence test dictates that a U.S. citizen is exempt from paying income tax on up to $105,900 of their income, provided that they lived outside of the U.S. for 330 days in a 12-month period. This 12-month period can start and end at any time during the year, meaning that you may have to take a deduction for two different tax years (prorated), unless your period of being outside started on Jan. 1.

For example, let’s say you left the United States on June 1, 2023, and you planned to return on May 31, 2024. So, you could take the FEIE on your 2023 tax year from June 1, 2023, through December 31, 2023, as well as the FEIE on income earned between Jan. 1, 2024, and May 31, 2024. Just remember to stay out of the United States and its territories (including American Samoa, Guam, the Northern Marianas Islands, Puerto Rico, and the U.S. Virgin Islands) for 330 days during this period.

Remember that you’re still on the hook for self-employment taxes, and you should still pay estimated quarterly taxes just as you would without the FEIE. The reason for paying the full amount of estimated taxes is just in case your circumstances change during the year. Plus, you’ll get a substantial tax return, which is always a nice bonus when you’re figuring out where to go next.

Tax Deductions for Contractors

Finding the right deductions to your taxes as a contractor will allow you to reduce your overall tax liability and put money in your pocket. That’s why you should look at every angle possible to find deductions. Here are some of the most popular:

Home office deduction
Office supplies and equipment, including your computer
Depreciating assets, which typically carry a higher value
Education expenses
Health insurance
Travel
Meals for business dinners or entertaining clients (alcohol not included)
Utilities

These are just a handful of deductions that most contractors take, but don’t be afraid to find some more on your own.

Tips and Tricks to Make Your Taxes (and Your Life) Easier

Pay Quarterly Taxes

One of the scariest scenarios of being an independent contractor is getting hit with a monstrous tax bill because you didn’t pay quarterly taxes. So to avoid this headache, let’s reiterate: You need to pay quarterly taxes. Failure to do so can often cause a heart attack around tax time, so put quarterly taxes at the top of your list.

Set Money Aside

As a general rule, you’ll want to set about 25% to 35% of your pay aside for taxes, depending on where you live or file taxes. Doing so will ensure that you always have enough money on hand and you don’t spend it.

Pro Tip: Put this money in an interest-bearing savings account so you can make a bit of extra cash on the money before you use it to pay your quarterly taxes.

Invest in Your Retirement

If you had a 401(k) or another retirement plan with an employer, you were riding high. As a contractor, the responsibility of a retirement plan lies on your shoulders. Fortunately, your personal retirement plan can also lower your tax liability. Each year, you can put up to $6,500 ($7,500 if you’re 50 or older) in a Traditional Individual Retirement Account (IRA). This also lowers your taxable income by $6,500, although you’ll have to pay taxes if/when you take money out of the account.

Don’t Forget Your Expenses (and Receipts)

Whether you need a box of paper clips or a $5,000 computer to run your business, you can use your purchases to reduce your taxes. Make sure to hold onto your receipts and always use your business expenses to cut your taxes as a contractor substantially.

No one loves giving a sizable portion of their hard-earned money to the government. But it’s a necessary evil that every contractor deals with eventually. Thanks to these tips, tricks, and plans, you’ll never have to stress about your taxes as a contractor.

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