When you provide services as a contract laborer or independent contractor, the Internal Revenue Service treats you as being self-employed. However, you have the same income tax obligations as an employee who earns a salary. The only difference is the way you report this income and how much money you can make before you must file a tax return. Unlike employees, contract laborers are responsible for paying self-employment tax directly to the IRS.
Contractor Filing Requirements
If you earn a substantial amount of income during the year as an independent contractor, you must report your earnings on a Schedule C or C-EZ attachment to your tax return. The IRS requires this even if you earn other income during the year as an employee. As of 2011, you must file a Schedule C with your personal tax return when you make $400 or more as a contract laborer. However, don't confuse this with your obligation to pay tax, since the income criteria for filing and paying are different.
Contractor Income Taxes
The IRS will not impose any more or less taxes on you just because you make money as an independent contractor. All taxpayers, regardless of employment status, don't pay tax on annual earnings up to an amount that equals the sum of your standard deduction plus one exemption. If you are a dependent to someone else, then you will pay tax on earnings that exceed just the standard deduction, since someone else claims your exemption. The standard deduction for each type of filing status is different. For example, head of household filers can earn more tax-free income than a single filer, since their standard deduction is much higher.
You also are responsible for paying self-employment taxes on your contractor earnings. These are the taxes that fund both the Social Security and Medicare programs and are separate from the federal income taxes you pay. Most employers will withhold these taxes from employee paychecks, but as an independent contractor, you aren't subject to such withholding. Instead, you calculate your self-employment tax liability on a Schedule SE attachment to your personal tax return. However, when preparing your tax return, you are eligible to claim a deduction for half of your self-employment tax payments.
Contractor Tax Benefits
One of the notable benefits of paying income taxes as a contract laborer is that the IRS allows you to claim deductions for many work-related expenses that most employee taxpayers aren't eligible for. This is because you are treated like a "business," and businesses have more freedom to fully deduct the expenses they incur to provide services. For example, if you perform all of your contract work at home, you can claim a deduction for office supplies, paper and even the miles you drive to the store to purchase these items. Many more types of expenses are deductible, but your eligibility for them will depend on the type of work you do.