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Are you a contractor wondering if you need to pay taxes?

Don’t worry, you’re not alone. And the answer is yes.

Contractors and independent contractors need to pay taxes like any other business professional or employee. There are some differences in the process, but both jobs end up paying up to the government.

In this article, we’ll talk about how each category of employee handles their tax filing and what type of construction tax benefits they can consider.

Key Takeaways for Contractors Confused About Tax Obligations

• Both contractors and independent contractors are required to pay taxes. However, their tax obligations and payment processes differ significantly based on their employment classification.
• Company-employed contractors benefit from employer-managed tax withholding through W-2 forms. Independent contractors (as sole proprietors) handle their own tax calculations.
• Independent contractors must typically make quarterly estimated tax payments, while company-employed contractors have taxes automatically withheld from each paycheck.
• Both types of contractors are responsible for federal, state, and local taxes, though independent contractors face additional obligations like self-employment tax.
• Record-keeping software is especially important for independent contractors who need to track all income and expenses.

Differences Between a General Contractor and an Independent Contractor

Employment classification plays a crucial role in determining tax obligations.

A contractor employed by a construction company is treated as a W-2 employee. The company they work for withholds taxes from paychecks and provides standard employee benefits.

In contrast, an independent contractor operates as their own business entity. They receive 1099 forms for their work. Independent contractors, as business owners, bear full responsibility for calculating and paying their own taxes.

This key distinction affects not only how taxes are paid but also who is responsible for withholding and reporting income to tax authorities.

End-of-Year Tax Forms

For contractors, the tax process is relatively straightforward. Companies provide contractors on their payroll with a W-2 form at the end of the year.

This document shows their total earnings, and the amounts already withheld for federal income tax, Social Security and Medicare.

Throughout the year, employers oversee tax withholdings and do so automatically. That’s why contractors see their taxes deducted from each paycheck. Think of it as having a financial co-pilot who manages most of your tax responsibilities on your behalf.

Independent contractors deal with a different situation. Instead of receiving a W-2, independent contractors typically receive 1099-NEC forms from each client who paid them $600 or more during the tax year.

Unlike contractors, independent contractor income doesn’t have taxes withheld from their payments. There are no taxes automatically deducted from their forms.

This means independent contractors are responsible for calculating and paying their own income tax and self-employment tax (which covers both the employer and employee portions of Social Security and Medicare taxes).

Hiring Paperwork

The onboarding paperwork requirements differ significantly.

Contractors simply fill out a W-4 form when starting a job. Independent contractors often need to complete W-9 forms for their clients and maintain detailed records of their income and expenses throughout the year.

These records become crucial during tax season, as independent contractors must report all their business income and can deduct qualifying business expenses – a benefit that most full-time employees don’t have.

Payment Cycle

A significant difference lies in the timing of tax payments.

Construction contractors typically pay taxes once per year during tax season (between January 1^st and April 15^th). That’s when you can make any necessary adjustments.

Independent contractors usually make quarterly estimated tax payments to the IRS. This system prevents independent contractors from facing a large tax bill at the end of the year and helps ensure steady tax revenue for the government.

These payments are due in April, June, September and January. Failing to make them can result in penalties.

Taxes Both General Contractors and Independent Contractors Pay

Day-to-day work for contractors and independent contractors is similar. However, their tax situations differ in important ways.

Both types of contractors share the fundamental responsibility of paying federal, state, and local taxes on their income. The difference is how the contractor calculates tax obligations. Physical payment also varies based on their employment classification.

Federal Income Tax

Federal income tax is an unavoidable reality. The process of paying these taxes differs significantly between contractors and independent contractors.

For company-employed contractors, the process is relatively straightforward. The employer handles much of the tax burden. They automatically withhold federal income tax from each paycheck based on the information provided in the contractor’s W-4 form.

This means contractors don’t have to worry about calculating and setting aside tax payments throughout the year. During tax season, contractors receive a W-2 form showing total earnings and the amount of tax already withheld.

Independent contractors, shoulder more responsibility for managing tax obligations.

Since they work for themselves, independent contractors must calculate and pay their federal income tax through quarterly estimated payments. These payments are due every April, June, September, and January. The amount owed depends on net earnings.

Net business earnings = total revenue – allowable business expenses (like tools, equipment, and business-related travel)

Despite these different payment methods, everyone pays taxes based on the same federal tax brackets. Total taxable income determines tax rates, regardless of how you receive your income.

One significant advantage that independent contractors have is greater control over their tax deductions. They can typically claim more business-related expenses than employed contractors. In turn, this could potentially reduce their overall tax burden.

However, this benefit comes with the added responsibility of maintaining detailed records and receipts throughout the year.

A practical tip for independent contractors is to set aside 25-30% of their income for taxes to avoid surprises at tax time. Company-employed contractors usually don’t need to do this since their employer handles the withholding.

That said, contractors might want to periodically review their W-4 to ensure enough tax is being withheld.

Understanding these differences and similarities can help both types of contractors better manage their tax obligations and avoid unexpected tax bills when filing taxes.

State Taxes

State income taxes are more complex than federal taxes for both company-employed and independent contractors. The amount you owe – and whether you owe anything at all – depends entirely on where you live and work.

For company-employed contractors, state tax withholding typically mirrors the federal system. An employer withholds state taxes from paychecks based on the state’s tax rates and withholding forms.

States like California and New York have progressive tax systems with multiple brackets. States like Pennsylvania use a flat tax rate for all income levels. Contractors working in states like Texas, Florida or Nevada don’t pay any state income tax.

Independent contractors face a more hands-on approach to state taxes. In states with income tax, they usually make quarterly estimated state tax payments alongside federal payments.

This requires careful planning and awareness of state-specific rules and deadlines. Some states follow the federal quarterly payment schedule. Other states set their own dates, adding another layer of complexity to tax planning.

The situation becomes even more intricate for contractors who work across state lines.

Company-employed contractors might need to file multiple state tax returns if they work on projects in different states. Their employer typically handles withholdings for each state.

Independent contractors must track their income by state and may need to file returns in every state where they earned significant income. They still need to file taxes even if their home state doesn’t have an income tax.

All contractors must understand their state’s specific requirements. This includes knowing the tax rates, filing deadlines and any special rules that might apply to their situation.

Local Taxes

Local income taxes add another dimension to the tax obligations of both company-employed and independent contractors. Municipal or county-level taxes can significantly impact your overall tax burden, particularly in major metropolitan areas.

For company-employed contractors, local tax collection usually happens seamlessly through payroll deductions. The company’s payroll department typically withholds these taxes based on where the contractor works. In some cases, companies also withhold taxes based on where the contractor lives.

Cities like New York, Philadelphia and Detroit have their own income taxes. Employers must withhold taxes for work in these cities like federal and state taxes. Some municipalities even have different rates for residents versus non-residents who work within city limits.

Independent contractors must navigate local tax requirements on their own. This can be particularly challenging in areas with multiple overlapping jurisdictions. For instance, an independent contractor in Ohio might need to pay taxes to both their city of residence and any cities where they perform work.

Unlike company-employed contractors, independent contractors often need to make periodic payments directly to local tax authorities.

The complexity increases in metropolitan areas where contractors work across multiple jurisdictions.

A company-employed contractor might have their employer handle different local tax rates as they move between jobsites in different cities. Independent contractors must track their income by location and understand the tax obligations for each jurisdiction where they work.

The key to managing local taxes is to stay informed about your obligations in each jurisdiction where you work. Maintain detailed records of where you earn your income. This is especially crucial for independent contractors who must handle these calculations and payments without the support of an employer’s payroll department.

Types of Taxes for General Contractors

Contractors are responsible for paying several types of taxes just like traditional employees.

Let’s examine the main categories of taxes that affect contractors.

Social Security and Medicare (FICA)

The Federal Insurance Contributions Act (FICA) tax represents a crucial part of the American social safety net. It funds both Social Security and Medicare programs.

For company-employed contractors, FICA taxes are straightforward but often misunderstood.

The employer automatically withholds 7.65% of your gross wages, with 6.2% going to Social Security and 1.45% to Medicare.

The key benefit of being a company-employed contractor is that the employer matches this contribution. They effectively pay half of the contractor’s total FICA obligation. When a contractor looks at their pay stub, these deductions are separate, showing exactly how much goes to each program.

Types of Taxes for Independent Contractors

Independent contractors are responsible for several types of taxes that company-employed contractors typically don’t have to manage directly. Understanding each type helps you properly plan your finances and ensure compliance with tax laws.

Let’s examine the main categories of taxes that affect independent contractors.

Self-Employment Tax

Instead of FICA tax, independent contractors pay Self-Employment Taxes (SE tax). This covers the same programs but at double the rate – 15.3%.

This higher rate exists because independent contractors must cover both the employer and employee portions of these taxes. However, they can deduct half of their SE tax when calculating their income tax, providing some relief from this higher burden.

In 2024, only the first $168,600 of earnings is subject to Social Security tax. However, Medicare tax applies to all earnings, regardless of amount.

Higher earners (those making over $200,000 for single filers or $250,000 for joint filers) pay an additional 0.9% Medicare tax on earnings above these thresholds.

Independent contractors must calculate and pay their SE tax quarterly along with their estimated income tax payments. This requires more careful budgeting and financial planning to ensure they set aside enough money to cover these obligations.

Sales Tax

Independent contractors might need to collect and remit sales tax if they sell physical products or certain services as part of contracting work. Sales tax requirements vary by state and locality.

Independent contractors must understand their sales tax obligations on materials and services. Some states exempt certain services from sales tax while taxing others, making it crucial to understand local regulations.

Business Property Tax

Independent contractors who own business equipment, vehicles, or property may face property taxes. These taxes are usually assessed at the local level and can vary significantly by location.

Even if working from home, some business equipment might be subject to property tax. It’s important to check local regulations and maintain accurate records of business assets.

Importance of Keeping Accurate Records for Tax Purposes

Record-keeping might not be the most exciting part of running your contracting business, but it’s necessary for managing your tax obligations effectively.

Every receipt, invoice, and financial document tells a part of your business’s story. Properly maintaining these records can make the difference between a smooth tax season and a stressful audit.

As a contractor, you need to track your income and expenses throughout the year. This means keeping detailed records of all client payments, including those documented on 1099-NEC forms.

On the expense side, you’ll need to save receipts for any business-related cost (like office expenses) that could qualify as tax deductions including:

• Materials
• Equipment
• Vehicle expenses
• Insurance premiums

The IRS requires contractors to maintain tax records for at least three years from the return’s filing date. But keeping records organized isn’t simply about meeting IRS requirements. It’s about protecting yourself and maximizing your tax benefits.

Well-documented records help you claim all eligible deductions confidently. It also provides necessary evidence if you’re ever audited. Without proper documentation, you might miss out on valuable business deductions or struggle to defend the ones you’ve claimed.

Beyond tax compliance, good record-keeping provides valuable insights into your business’s financial health. These records help you:

• Understand your profitability
• Track expense patterns
• Apply for loans
• Make strategic business decisions

Investing time in maintaining accurate records throughout the year is far easier than scrambling to gather documentation during tax season or an audit.

How Contractors Can Avoid Tax Headaches With Construction Payroll Services

Construction payroll services offer specialized solutions that address contractors’ unique tax challenges. These services handle complex tax calculations, including:

• Federal income tax
• Self-employment tax
• State-specific requirements

Payroll services ensure accurate withholdings and timely payments. They also manage certified payroll requirements and union regulations, reducing compliance risks.

The key benefit of construction payroll services is the automation of tax-related tasks. Automations help:

• Calculate tax obligations
• Generate required forms like 1099s and W-2s
• Track project-specific labor costs

This significantly reduces errors that often lead to tax problems. It also maintains detailed digital records of all payroll transactions, making responding to audits or tax inquiries easier.

See How Payroll4Construction Can Help You With Tax Obligations

Understanding and managing your tax obligations as a contractor (not to mention identifying your construction tax benefits) doesn’t have to be overwhelming. You can efficiently handle your tax responsibilities while focusing on growing your business by:

• Implementing proper record-keeping practices
• Using modern accounting software
• Staying informed about different tax requirements

Remember that tax compliance isn’t only about avoiding penalties—it’s about creating a sustainable foundation for your contracting business that allows you to make informed financial decisions.

With Payroll4Construction, contractors can receive industry-specific expertise in construction payroll processing.

Construction payroll is unique compared to other industries, including dealing with things like multi-state taxation, prevailing wage requirements and certified payroll reports. Payroll4Construction provides automated tax calculations and filings, ensuring accurate tax withholdings and timely deposits.

With dedicated support from construction payroll specialists, contractors can focus on their core business while knowing they are correctly handling tax obligations.

For more information, speak with an expert today.