Introduction to Taxes
As an independent contractor or business owner you are responsible for filing and paying taxes on your income. Learning about taxes can be confusing and intimidating, but once you know the basics it gets easier to understand how things work. In fact, knowing how to effectively manage your taxes can help ensure that you are maximizing the money you keep. This topic will cover the basics for what you need to know to manage and file your taxes with confidence.
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Individual Taxpayer ID Number (ITIN)
Tax forms require unique identification numbers so that the IRS can keep track of your information. The ITIN is a taxpayer identification number for those without a Social Security Number or who are ineligible to receive one. If you do not have a SSN, an ITIN or an EIN (which will be covered in the next module) is an alternative that allows you to file your taxes.
All immigrants regardless of legal status are able to earn a living as an independent contractor or start a business and file taxes using a Social Security Number (SSN), Individual Taxpayer Identification Number (ITIN), or Employer Identification Number (EIN).
Your Responsibility as a Taxpayer
It’s exciting when you begin to earn money for your services as an independent contractor or start making profits as a business owner! It can be tempting to start spending your hard earned money on things you want and need, but don’t forget about your obligation to pay taxes. As an independent contractor or business owner it is your responsibility to file and pay federal, state, and local taxes on all income. This topic will help you become familiar with tax processes that may seem overwhelming at first but will become easily manageable once you know how things work.
What You Need to Know About ITIN
In order to file your taxes, the government needs a way to identify and keep track of the income you earn. This is done through a tax identification number and is the same number used by credit bureaus to determine your credit score (see Finance & Capital). For those eligible, this is your Social Security Number (SSN). If you do not have or are ineligible for a SSN you may file for an Individual Taxpayer Identification Number (ITIN) regardless of immigration status. ITINs are issued by the US Internal Revenue Service (IRS). The IRS is the nation’s tax collection agency and is responsible for administering the federal tax code.
ITINs allow individuals ineligible for a SSN to:
- Report their earnings to the IRS
- Open interest-bearing bank accounts with certain banks
- Open checking accounts with certain banks and build credit
- Conduct business in the U.S.
- Access personal and business loans
The IRS issues ITINs regardless of immigration status, because both citizens and noncitizens may have a U.S. tax filing or reporting requirement under the Internal Revenue Code. That means that regardless of immigration status, if you earn more than $400 in the U.S. or meet any other filing requirement you are required to pay taxes on your income.
How to Apply for an ITIN
It can be complicated to apply for an ITIN by yourself if you are unfamiliar with the process. We suggest working with a professional if you can. For more detailed information and a step-by-step guide through the application process please watch the Immigrant’s Rising webinar ITIN 101: EVERYTHING YOU WANT TO KNOW ABOUT ITINS, BUT DON’T KNOW WHAT TO ASK.
You can complete your ITIN application through the Internal Revenue Service by filling out form W-7 – Application for IRS Individual Taxpayer Identification Number.
Limitations of the ITIN
Not a valid form of identification
ITINs are not valid identification outside the federal tax system. Since ITINs are strictly for tax processing, the IRS does not apply the same standards as agencies that provide genuine identity certification (e.g. state IDs/ driver’s license, passports, green cards, etc.). However, some states may accept the ITIN as part of the driver’s licence application or verification of residency.
Does not change immigration status
ITINs are for federal income tax purposes only. Getting an ITIN does not change your immigration status or your authorization to work in the United States.
Ineligibility for some benefits
An ITIN does not provide eligibility for Social Security benefits or the Earned Income Tax Credit.
Several important changes have been made to the ITIN application and process since its inception in 1996:
- Since 2003 the IRS began to tighten standards for issuing ITINs by requiring tax returns as proof that the ITIN would be used for tax administration purposes. The IRS also announced that it would change the appearance of the ITIN from a card to a letter to avoid possible similarities with the SSN card.
- In 2012 the IRS announced revised procedures for the 2013 filing season, requiring original documents or copies certified by the issuing agency for most applications. Moreover, on November 29, 2012, the IRS announced for the first time that ITINs would expire after five years. They also announced that Certifying Acceptance Agents (CAAs) would be allowed to engage in the ITIN application process by reviewing original documents or copies certified by the issuing agency.
Once renewed, an ITIN will remain in effect unless it is not used on a tax return for three consecutive years. It is important to note that the issuance date of a renewed ITIN is the date the ITIN was originally issued, not the renewal date.
What may happen if an ITIN is not renewed?
It can be easy to forget to renew your ITIN if you haven’t filed a tax return in a while. The IRS will still accept a tax return if the ITIN is expired but may delay processing and the application of certain tax credits. This could result in a reduced refund or additional penalties and interest.
Confidentiality of ITIN Information
IRS Code § 6103
Under current law, information on the ITIN is protected from being shared with other federal agencies, including immigration agencies. ITIN information is partially protected by Internal Revenue Code § 6103, which generally prohibits the IRS from disclosing taxpayer information. To change the confidentiality of tax related information, including ITIN information, Congress would have to change the law.
However, there are important exceptions that you should be aware of. In general, the IRS is required to disclose taxpayer information to:
- State agencies responsible for tax administration
- Law enforcement agencies for investigation and prosecution of nontax criminal laws
- Powers of attorney and other designees.
The IRS may also provide limited disclosure of information in the course of official tax administration investigations to third parties if necessary to obtain information that is not otherwise reasonably available.
Historically, the IRS has been very invested in maintaining the confidentiality of its information, since the IRS does not want to see the inevitable reduction in tax revenue that would result if the confidentiality protections were weakened. However, no one can predict what different government administrations may try to do. Therefore, undocumented immigrants should know that there is some risk associated with applying and filing for a ITIN.
Newly Assigned SSN
An individual with an expired ITIN who has obtained or become eligible for an SSN (for example through DACA) should not renew the ITIN and should discontinue using it. It is improper to use both the ITIN and the SSN assigned to the same person to file tax returns.
Notify the IRS about your new SSN
The IRS will void the ITIN and associate all prior tax information filed under the ITIN with the SSN. It is your responsibility to notify the IRS so it can combine all of your tax records under one identification number. If you do not notify the IRS when you are assigned a SSN, you may not receive credit for all wages paid and taxes withheld, which could reduce the amount of any refund due.
Individuals who become eligible to obtain a SSN (i.e. DACA or permanent residents) should obtain one from the Social Security Administration (SSA) and visit a local IRS office, or write a letter explaining that you have now been assigned a SSN and want your tax records combined.
In your letter you should include:
- Your complete name
- Mailing address
- ITIN along with a copy of your social security card and a copy of the CP 565, Notice of ITIN Assignment, if available.
Send your letter to:
Internal Revenue Service
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Employer ID Number (EIN)
In addition to the SSN or ITIN, people who decide to form a business may choose to apply for an Employer Identification Number (EIN) to identify a business entity.
Do You Need an EIN?
Similar in purpose to the SSN assigned to individuals, EINs are used by employers, sole proprietors, corporations, partnerships, non-profit organizations, trusts and estates, government agencies, certain individuals, and other business entities. An SSN or ITIN may be used to apply for an EIN.
According to the IRS, you will need an EIN if you answer “Yes” to any of the following questions:
- Do you have employees?
- Do you operate your business as a corporation or a partnership?
- Do you file any of these tax returns: Employment, Excise, or Alcohol, Tobacco and Firearms?
- Do you withhold taxes on income, other than wages, paid to a non-resident alien?
- Do you have a Keogh plan?
- Are you involved with any of the following types of organizations?
- Trusts, except certain grantor-owned revocable trusts, IRAs, Exempt Organization Business Income Tax Returns
- Real estate mortgage investment conduits
- Non-profit organizations
- Farmers’ cooperatives
- Plan administrators
Applying for an EIN
You can apply for an EIN online, by fax, or mail depending on how soon you need to use the EIN. Applying for an EIN is a free service offered by the IRS. Beware of websites on the Internet that charge for this free service.
For more detailed information about the application process for the EIN, see the IRS website page How to Apply for an EIN.
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Filing Taxes as an Independent Contractor
Filing your taxes as an independent contractor is very different from filing taxes as an employee. As a self-employed individual, generally you are required to file an annual return and pay estimated tax quarterly
When you work for yourself, there are no deductions from your paycheck for income taxes, social security or Medicare, as would be the case if you were working as an employee. As an independent contractor or small business owner, you are held responsible for paying federal and state income tax, social security and Medicare; this combined tax is called self-employment tax for independent contractors.
Organize and Prepare
As an independent contractor, the most important aspect is to organize and prepare. A few things you should consider and prepare for are:
- Seeking tax preparation assistance or finding a reliable tax preparer or accountant, especially if it’s your first time filing. To find support in finding a tax preparer visit the Taxpayer Advocate Service.
- Be prepared to pay both federal and state, and in some cases local or city, taxes
- Keep track of your income (both as an employee and IC)
- You will receive a W-2 form as an employee and a 1099 form for work done as an independent contractor.
- You will only receive a 1099 if you made $600 or more for a particular client.
- You will need to report income from small jobs separately
- Keep track of your business expenses
- It is recommended that you keep receipts of all of your expenses for at least 6 years.
- Consider using an App to keep track of receipts such as Quickbooks or Foreceipt.
- Pay quarterly estimated taxes if you expect to pay more than $1,000 in taxes annually.
Keep up with changes
The IRS makes updates, corrections, clarifications, and changes to tax filing requirements, forms, and procedures throughout the year so it is important to stay up to date and aware of any changes that might affect you before filing. For updated information about changes you can visit the irs.gov website.
Tax Preparation Assistance
You may file your independent contractor or business taxes on your own, but we recommend working with a reliable tax preparer or accountant (especially if it’s your first time filing as an IC), who can help you complete the correct tax forms and help you determine your deductions and expenses.
At the end of the day there is no one right or best way to prepare your taxes, you are the only one who can find the best tax preparation path for your needs. The key is to be informed, do your own research and ask questions.
Assistance with filing your own tax returns
The IRS can help many taxpayers prepare their own returns without the assistance of a paid preparer. Some options you can consider include:
- Free File Software if your income is $62,000 or less and Free File Fillable Forms if your income is greater than $62,000.
- You may also use commercial tax preparation software to file your taxes electronically.
- You may find an authorized IRS e-file provider in your area through the IRS using the IRS e-file Provider Locator.
- There is also a free tax return preparation for qualifying taxpayers available through programs such as the Volunteer Income Tax Assistance Program (VITA) and Tax Counseling for the Elderly (TCE).
Finding a professional tax preparer
Similar to immigration services, you should be very careful when choosing a tax preparer. You do not want to become a victim to any scheme that offers unrealistic wealth or exemption from your obligation to file tax returns and/or pay taxes.
What to look for
While most preparers provide excellent and honest service to their clients it is important to know that even if someone else prepares your return, you are ultimately responsible for all the information on the tax return, which is why it is very important to choose your tax preparer wisely.
When when searching for a tax preparer you should:
- Check the person’s qualifications
- Check the preparer’s history
- Find out about their service fees
- Ask if they offer electronic filing
- Make sure the tax preparer is accessible and can answer your questions when needed
- Provide all records and receipts needed to prepare your return
- Never sign a blank return
- Review the entire return before signing it
- Make sure the preparer signs the form and includes his or her preparer tax identification number (PTIN).
Forms to Know
There are a few forms you need in order to file your taxes.
- W9 Form – you will be asked to submit this form to each client so they can keep track of how much they pay you.
- 1099 Form – this form is a summary of how much a client (or clients) paid you (if more than $600) mailed to you at the end of the year by each client.
- Form 1040 – form used to report self-employment income.
- Schedule C EZ Form – (no longer used for tax years 2019 and later) form used to calculate net profit from business (used for
- smaller businesses) if:
- Your business expenses are less than $5000
- You have no employees
- You have no physical inventory
- You are not using depreciation or deducting the cost of your home
- Schedule C Form – used to calculate profit or loss from business (used for more complex businesses).
Schedule SE Form – used to determine how much you pay in social security and Medicare taxes (in addition to income tax).
Expenses and Deductions
As an independent contractor or business owner, the IRS allows business expenses to be deducted from your earnings; expenses must be business expenses and not personal. What this means is that you only pay taxes on the money left over after you deduct business related expenses from money earned.
Keep a record of expenses
For any business expense, you must keep record of each expense (date, purpose, amount, and copy of receipt) to prove that it was a business expense in case of an audit. You want to take as many legitimate deductions as you can, but you must be able to prove that the money was spent and that it was used for business purposes.
We recommend keeping a ledger of all expenses and deductions with detailed notes to help you file taxes and be prepared in case of an audit.
Common business expenses
Below is a list of common business expenses:
- Advertising expenses
- Business insurance
- Interest paid on business credit card or business loans
- Professional services (i.e. lawyers, accountants, tax preparers)
- Repairs for equipment
- Office supplies
- Travel costs
- Business meals and other entertainment
- Student loan interest deduction
- Tax benefits for education
For more detailed information about business expenses, see IRS Publication 535, Business Expenses.
Managing Cash-Flow and Saving for Taxes
As an independent contractor or business owner, it is important to learn to manage your cash flow by making sure you are charging enough to cover business expenses and taxes, and maintaining a consistent flow of projects/clients.
Research hourly rates of people who do similar work to you, negotiate your billable hours, and determine how many clients and projects you need to have at any given time to keep you financially stable.
Keeping track & making a budget
It is important to keep track of the hours you work and submit invoices to clients on time. You should also keep track of when and how long it takes for clients to pay invoices. There are two great ways to keep track of your cash-flow and ensure you are preparing to cover your taxes.
- Create a budget to keep track of your expenses and revenues, and forecast a couple of months ahead to keep your finances in check.
- Open a separate savings account to put aside at least 25% of your income to pay for taxes.
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Check out these resources for more detailed information about ITINs, EINs, and filing taxes as an independent contractor.