Self-employed individuals, also known as independent contractors, are considered a small business; like other businesses may have to pay income taxes on their taxable profits; in addition 1099 recipients has to pay 15.3% self-employment tax, which if added together with income taxes can a considerable percentage of the total taxes due during the tax year.
When you are compensated on your personal name, you receive the Form 1099, which the payer reports to the Internal Revenue Service (IRS), by January 31st, when filing their 1099s. The total reflected on that Form 1099 must be reported on the Profits or Loss from Business Schedule C (Attached to Form 1040) for sole proprietorship. If any profit is reflected on the Schedule C, it is subject to 15.3% of taxes which is the social security and medicare tax (7.65% x 2 = 15.3%), in addition to the income taxes starting at 10%.
If you set up a business entity, like an S Corporation for single owners, you would have the ability to split the profit allocated between employment wage taxes of 15.3% plus income taxes and investor dividends or distribution from Form K-1: Owners Share of Profits, Losses, Gains, Credits, etc. which are only assessed income taxes and start at 10%, this should lower the overall amount of taxes you would have to pay, compared with what you pay on the schedule C. The S Corporation only files a tax return to disclose revenue, expenses and taxable profit, but, do not pay federal income taxes. The K-1 profit or the loss is reported by the sole-proprietor on the individual income tax return and profits are paid by estimated personal income tax deposits quarterly, Form 1040ES.
The S Corporation entity could help an independent contractor to get more income reported on their personal tax return for less tax cost to help qualify for personal financing.
In the meantime, keep paying quarterly estimated income and payroll taxes to avoid issues with the IRS tax rules known as “Reasonable Compensation;” Simply meaning that you are still required to report payroll and pay the 15.3% tax on what a market salary survey would appraise your annual salary for the job you do, in the size of company you run, with your demographic location, amongst possible other considerations, in order to beat an IRS audit, if questioned.
Another advantage of forming an S Corporation is that personal protection limiting your professional liability to what you invested into the company, which may eliminate the risk of being sued on the personal asset, as long as you adequately maintain your “Corporate Shield.” Consult your corporate legal attorney to make sure your business entity provides the best protection and the rules to maintain your Shield.
If you are an independent contractor and still have not set up the business entity that fits best your case, we recommend you to consider it. Contact your legal counsel or qualified representative to properly set up your US business entity. If you need assistance, Rosillo & Associates, www.RosilloCPA.com and we can assist you at (305) 477-5671.