Every self-employed person must be aware of the independent contractor taxes California that they have to pay. A person who is more or less their own employer will have to learn how to pay their own taxes and how much they should save with estimated tax in mind. This article will bring you the information you need about these self-employment taxes that you must pay.
What Is an Independent Contractor?
An independent contractor is a worker who takes on freelance jobs on a frequent basis. They take on a project, complete it, and then receive payment from their clients through form 1099.
Independent contractors have the freedom to choose the contracts that they want and when they want to work. They collaborate with an employer or a company, but they have no ties with anyone specific.
Rather, they may take jobs from multiple clients - even from companies that are competing with one another. Independent contractors can work in both short-term and long-term projects.
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How Are Workers In California Classified as Independent Contractors
To classify someone as an independent contractor, California uses something called the "ABC Test." This test is used to determine whether the worker is covered by the Unemployment Insurance Code and the California wage orders or not.
Under this test, the worker may be classified as an independent contractor by the hiring entity's business only as long as he or she meets the conditions below:
A - Works Outside the Control of the Business
An independent contractor will work outside the guidance of a business. In other words, independent contractors decide how they operate, and the hiring company can decide whether they accept their terms or not.
They have their own hours, use their own transportation methods, and no one supervises their job - as long as they finish their tasks when it was decided.
B - Performs Jobs That Aren't Related to Core Business
Independent contractors perform jobs that are normally not related to the core of the business. The work they provide cannot be the same as the work that is done by a regular employee. What they do should be set outside the usual course of the hiring business.
C - Works Independently In the Established Trade
An independent contractor will work separately in their established trade, business, or occupation. The work or business of the independent contractor needs to continue even after the contract with the hiring business is over.
If the worker does not meet all of the "ABC" conditions, then under California's law, they will be classified as an employee. This applies even if the worker can be qualified as an independent contractor under the Affordable Care Act or the federal tax law.
What If a Worker Is Misclassified?
If an employer misclassifies a worker and labels them as an independent contractor, but handles them like an employee of the business, then the employer may face a lawsuit.
A worker who was misclassified is fully entitled to file a wage per hour lawsuit. This way, they will be able to receive worker's compensation for the benefits they should have received.
These benefits may include:
- The unpaid wage for meal breaks or rest
- Unpaid overtime
- Interest on unpaid wages
- Attorney fees
- Penalties
If the wrongful classification was done on purpose, then this violation of the law may come with a variety of consequences. Not only would the business have to pay workers' compensation, but the civil penalty may be between $5,000 and $15,000 for every violation.
Things can become even more expensive for the employer if there was a pattern in these miscalculations. If they willfully misclassified workers time and time again, then the penalty may go around $10,000-$25,000 for each benefit violation, along with workers' compensation.
That being said, if the misclassification was not a result of the employer's willfulness, the employer also has the right to sue. This is common in cases where the employee received financial damage because of the misclassification. A lawsuit may be filed against the party who was responsible for the misclassification.
Who Does the State of California See as Self-Employed?
The State of California and the IRS have similar ideas when it comes to classifying someone as a self-employed individual. For instance, a business that is run by a sole proprietor is one clear-cut example of self-employment.
That being said, looking at the tax law, there may be some slight differences. Anyone who lives in California and runs a business, without being an employee or a specific company, may be considered a self-employed individual.
These examples may include, but aren't limited to:
- Sole proprietors
- Members within a partnership
- Part-time business owners
- Members of LLC companies
Usually, these types of businesses work in an outsourcing style, with independent contracts with other companies. The California tax law requires that these individuals pay their taxes by themselves, as they do not work for anyone else.
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How Are Independent Contractors Different from Employees?
In order to understand the differences between an employee or an independent contractor, you first need to understand what an employee is. A worker is an employee when they have signed an employment contract with the company or employee that they decided to work with.
They receive their payment through Form W-2 and they have clear restrictions on what they can or can't do. An employer may dictate several aspects of their jobs, such as how they work or when they work. Employees will typically work full-time for that position.
On the other hand, a worker is an independent contractor when they have the benefit of being free and are not bound by the rules of a certain employer. They are free from the control of an employee, and may also work outside the usual course.
There are federal tax payments for an employee or an independent contractor alike. However, employees pay their employment taxes through income tax withholding, whereas independent contractors have to pay these taxes themselves.
How Much Social Security and Medicare Taxes Does an Independent Contractor Pay in California?
The self-employment tax (also referred to as the Social Security and Medicare tax) often varies from year to year. The current self-employment income tax is 15.3%.
From that amount of tax, 12.4% of it will go to Social Security. It will also be collectible of a maximum of $118,500 for the net earnings. The last 2.9% will go to Medicare, having no limit to collectible earnings.
Independent contractors have to pay Social Security and Medicare for both the employer and the employee. In other words, they will pay their own taxes, along with the portion for their clients. As a regular worker, they'd only pay 7.65% - but as a regular worker, that amount doubles.
Try our California 1099 tax calculator to quickly see how much you'll owe at the end of the year.
In order to reduce the total liability, you'll want to take advantage of tax deductions by itemizing your expenses at the end of the year.
How Much Money Should I Set Aside For Income Tax As an Independent Contractor?
While independent contractors have a Social Security and Medicare Tax they have to deal with, this is not always all they have to pay. In addition to that, there may be other income tax payments or federal income taxes that they will have to pay.
As a result, it is recommended that as an independent contractor, you should save somewhere around 25%-30% of your earnings to pay your taxes. Obviously, the amount of income tax money can depend on exactly how much you earn.
The more you earn, the more tax money you will have to pay. This is why you might want to keep an eye on your earnings, as well as any changes in the tax law. In many cases, the Internal Revenue Service (IRS) will offer you a tax calculator so that you will know exactly how much you should file. Read our guide on how to pay less taxes in California to discover more ways to save money on your taxes.
How Do I Pay Taxes as an Independent Contractor
If you are an independent contractor, then you are the one responsible for paying your taxes on their due date. With that in mind, depending on your income, you may need to pay both annual returns and file California quarterly taxes.
You are also responsible for paying your state and federal income tax, where it is applicable. Bear in mind that the more deductions you can determine, the more money you should be able to save in the long run. Read more about hacks to lower your taxes.
Filing for the Annual Return
If you owe less than $1,000, then you will only have to file for your annual return after paying your yearly taxes. To file for those taxes, you will need to get your hands on the Schedule C form (here are the instructions to file it).
Use the income that was calculated on this form and determine how much you should pay in Social Security and Medicare taxes. Independent contractors should use form 1040 or form 1040-ES in order to report these taxes
Filing for Quarterly Taxes
If you owe more than $1,000, then as an independent contractor, you need to file your taxes quarterly rather than yearly. The first thing is determining your adjusted gross income that came from self-employment during the tax year.
The more tax deductible expenses you may find, the less you will have to pay in terms of taxes. Form 1040 provided by the IRS can work as a spreadsheet for you, to help you determine exactly how much you will have to pay in estimated Taxes
What Tax Does an Independent Contractor Pay?
Independent contractors may have a variety of taxes to pay, mostly depending on the state that they are in and the law that governs throughout that tax year. A self-employed person in California will have to pay the following employment taxes:
- Social Security and Medicare Taxes (i.e., self-employment tax)
- Federal Income tax
- Annual LLC fees
California may also impose its own tax, provided you have a business or an LLC.
Does California Have a Separate Self-Employment Tax?
Technically speaking, the Social Security and Medicare taxes in California are the same as with the other states. That being said, the difference is in the other taxes that California has you paying. Surprise or not, the state of California has some of the nation's highest tax rates.
California also imposes income tax on S corporations, being one of the very few states that does this. If the LLC has to pay taxes like an S Corp, then the income goes through and is taxed based on your individual tax return.
As a result of this, aside from your individual state and federal taxes on your LLC income, you will also have to pay an extra 1.5% dealt by the state of California. In most cases, it will depend on the status of your business.
Tax Forms for Independent Contractors
If a worker was classified as an independent contractor, then the hiring party should provide the worker with potential different forms:
Form 1099-NEC For Non-employee Compensation
Most freelancers file a 1099-NEC. It is the most common IRS tax form sent to contractors. The reason why is because the requirement to receive this information return is really easy to meet. If you are paid at least $600 by a business who is not your employer, you will receive a 1099-NEC from them.
Form 1099-K for Payment Card and Third-Party Network Transactions
Form 1099-K typically contains the gross income that was received as a result of a third-party transaction. This will also include gig party transactions.
Similarly, form 1099-K will contain the number of payments that were received, along with any potential state or federal income tax withholding.
Form 1099-MISC for Miscellaneous Income
Form 1099-MISC is used for elements such as royalties, rents, workers' compensation, and other types of income. Independent contractors have no Social Security and Medicare withholding, but they need to take care of their own federal tax returns.
Unemployment insurance tax is not necessarily required to be paid by the worker. That being said, if they want it, they may choose to do so as well.
The Bottom Line
Independent contractors in California are different from regular workers, as they have the right to control their manner of business. That being said, they still need to put money aside for taxes, because after all, the IRS spares no one. Calculate how much you must pay every year so that you may avoid a potential penalty. Make sure that you are not misclassified either, as it may cause you to pay a whole load of different taxes.
