Although tax time is a painful hassle for nearly every American, it can be particularly intimidating to independent consultants. Most professionals who perform consulting work on a full-time basis are self-employed. This means that, unlike the traditional contract worker, no company is withholding or paying taxes for the independent consultant.
Independent consultants must, therefore, take much more of the tax planning, management, and payment processes into their own hands.
But first, before detailing the various tax issues that you must consider as an independent consultant, it will be useful to define exactly what this occupational category entails.
Do I Qualify as an Independent Consultant?
To file taxes as an independent consultant, you must qualify as an independent consultant in the eyes of the Internal Revenue Service (IRS). Although the official IRS guidelines leave a certain amount of room for interpretation, the key element that separates an employee from an independent consultant is control.
In other words, if your paycheck is signed by parties that tell you exactly what to do and how to do it, you are certainly not an independent consultant. However, if they offer some guidance but generally allow you to work on your own, you are likely to bean independent consultant. Other key aspects of independence consultancy include:
- Setting your own rates of payment
- Working for clients who have the independent right to accept or decline your services
For the most part, employment status is decided by the employing party rather than the employed, so your individual “bosses” are typically the best go-to resource when it comes time to file your taxes. If you are receiving no benefits at all from your employer, you are very likely an independent consultant or another type of contract employee.
The Basics of Consulting Taxes
Unless they’ve taken steps to incorporate or establish themselves as another type of business entity, independent consultants are generally considered "sole proprietors" by the IRS. As such, the IRS requires them to report and file their business taxes along with their personal income taxes.
In order to do this, sole proprietors must complete a Schedule C form to determine and report their net business income on an annual basis. In addition to showing total business revenue, the Schedule C allows you to deduct all reasonable and necessary business expenses from your total income to arrive at your final taxable business income.
If you are filing as a sole proprietor, you are subject to self-employment taxation through the IRS. All US workers must pay Medicare and Social Security taxes in addition to income tax. While traditional employees split the cost of Medicare and Social Security taxes with employers, self-employed people must pay 100 percent of them.
The combined Medicare and Social Security tax burden changes annually according to rates of inflation and other economic factors. In 2021, the IRS is taxing Medicare at 2.9 percent of net income and Social Security at 12.4 percent of net income up to a wage base of $142,800.
Quarterly Tax Payments
If you are a traditional employee, the IRS requires your employer to withhold taxes and pay them on your behalf throughout the year. On the other hand, if you are an independent contractor, no one is doing this for you. This means you are required to do it yourself in the form of quarterly estimated tax payments.
In order to estimate your quarterly tax payments, you must first estimate what your yearly consulting income, business overhead expenses, and combined tax deductions will be. Consider securing the services of a qualified tax professional, as this will be an invaluable resource when it comes to calculating the right quarterly payment amount for you. The IRS also provides plenty of helpful information on estimated taxes.
To avoid penalty fees, estimated quarterly tax payments must be made before the following deadlines in 2021:
- April 15
- June 15
- September 15
- January 15
Tax Tips for Independent Consultants
In terms of taxes, the most important thing for an independent consultant to consider is expense deduction. Although your specific deductions will vary according to the nature of your business, common deductions might include:
- Office supplies
- Work equipment
- Marketing materials
- Travel/vehicle costs
If you work out of your home, you may also be able to deduct a percentage of your household utilities and other residential expenses. This is particularly true if you have a designated “home office” that you use exclusively for work purposes.
When it comes to tracking and recording financial activity for tax purposes, many consultancies and contract businesses have benefited immensely from the adoption of an automated system for tracking and managing taxes. These systems are often part of larger digital professional services platforms such as the comprehensive BQE CORE. In addition to faithful financial reporting, the CORE tax system can help you track and manage all aspects of your business taxes.
Filing taxes and managing tax matters as an independent consultant can be a bit tricky, but by paying attention to a few key areas and following some general guidelines, you can make the IRS happy without placing an undue burden on your financial bottom line.