Being an independent contractor often means you’ll be treated as a self-employed business person – that is, you have complete control over the work you can take on.
However, this freedom comes with unique tax responsibilities that not all freelancers are aware of. As an independent contractor, your net income will go through peaks and troughs, which further complicates figuring out what you owe in estimated taxes.
Lots of record keeping
Starting your own business increases the amount of record-keeping you have to do, as you’ll have to dig through receipts and invoices dating back months and years to figure out your business expenses and income tax.
Since you don’t have an employer withholding taxes from your paycheck, it is upon you to calculate your taxes for the year and to set aside enough money to cover your tax obligations. You will have to pay income tax directly to the government. It can be challenging to figure out how much you will owe in taxes, especially if you recently began work as an independent contractor and aren’t sure about your earnings in a given tax year.
Deducting business expenses
As an independent contractor, you can deduct nearly every business expense, which can reduce your Medicare taxes and social security tax, which you pay as self-employment tax. Instead of a traditional W-2, you’ll have to fill out a W-9. This way, the business that hired you can prove to the IRS they don’t owe any payroll tax for your employment.
First things first: you’ll have to submit a 1099 form. This form applies to non-traditional employees regardless of the label they apply to themselves, whether it is a side hustler, self-employed, independent contractor, freelancer, or solopreneur. You must outline exactly how much you earned as an independent contractor over a year.
We’ve rounded up the following tax tips to make tax time less complicated and help you maximize the advantages of being a solopreneur.
Home office deduction
If you work from home, as most solopreneurs are prone to do, or use it in part of your business, then self-employment deductions on your utility bills can give you a huge break when filing quarterly taxes.
You can deduct the following: property taxes, a portion of your mortgage, cost of utilities, maintenance and repairs, and similar expenses. Note that this deduction is mostly only available to independent contractors and does not extend to employees.
The Internal Revenue Service requires you to specify the amount of square footage you will use for your business. That percentage of your rent or mortgage can be deductible. For example, if your home office takes 20% of your house’s square footage, 20% of the housing expenses for the year can be written off. Any miscellaneous expenses that you use for your business, say repairing the HVAC in your home office, can be fully deductible.
As you can imagine, an accurate home office deduction will require you to maintain many records, but you may end up with a lower deduction.
Health insurance deduction
You may qualify for a self-employment tax deduction on health insurance premiums if you purchased them for yourself. This also applies to premiums for your spouse, any dependents, and children who are younger than 27. The IRS Publication 535 has further rules for long-term care insurance premiums.
This does not apply to employees because their deduction is limited to expenses that exceed 7.5% of their adjusted gross income. So if an employee makes $100,000 in AGI, they can only deduct medical expenses that exceed their first $7,500.
If they spent $7,600 in combined insurance and medical expenses, they may only claim a $100 deduction based on the tax code. However, self-employed individuals can claim the entire $7,600 deduction. Either way, this write-off can make a huge difference at tax time, so make sure to take advantage of it if you can.
There are many companies that offer self-employed health insurance plans, we recommend starting at healthcare.gov. This is the federal government’s health insurance marketplace, where you can choose from hundreds of plans.
Education expenses are tax deductible
If going back to school is necessary for your business, you may be able to write the tuition off on your taxes. Self-employed individuals can deduct tuition and other educational costs from their self-employment income tax. These deductions not only lower the income subject to your income tax but to self-employment tax as well.
Just make sure to read the IRS Publication 970 to make sure your education qualifies as work-related tuition. To qualify, the classes must be either a legal necessity for you to stay in business or improve your skillset. This can include continuing education, college curriculums, and seminars.
Sometimes your vehicle may become an extension of your office, especially if your job requires you to go from one place to another, making deliveries or other business-related tasks. The good news is that expenses related to your car can be one of the biggest deductions for independent contractors.
The IRS standard mileage rate for tax write-offs is about 56 cents per mile. These rules keep changing every year, so make sure to review the official Internal Revenue Service website.
You can also deduct parking and toll expenses. Expenses related to extended meetings and projects may be very high. Include this in your receipt and add them to your 1099.
It is worth pointing out that the IRS will comb through your claims because 1099 workers rarely have vehicles that are only used for business.
Do you have a meeting with a client out of state or attending industry seminars? When it comes to business-related travels, your hotel costs, airfare, and 50% of meal expenses can be deducted from your tax burden. Even if you extend the trip for leisurely activities once business activities have ended, you can include any costs incurred as part of your tax deduction. Just make sure that the amount of leisure days on the trip does not exceed the total amount of business days.
For example, if you travel from Arizona to Beijing for a three-day industry seminar, you can extend the trip for an extra two days for leisure. 50% of the costs for meals and hotel stay during the extra two days can be deducted.
Self-employment taxes as tax deduction
Yes, you read that right; you can write off your self-employment tax as a business-related expense. It’s one of the most popular tax deductions used by independent contractors. The self-employment tax rate is 15.3%. It comprises 12.4% for Social Security and 2.9% for Medicare. Self-employment taxes apply to net earnings, which are referred to as profit.
Solopreneurs can deduct half of their self-employment taxes from their income taxes.
So if your Schedule SE says you owe $3,000 in self-employment tax for the year, you’ll need to pay that money when it’s due during the year, but at tax time, $1,000 would be deductible on your Form 1040.
Note that if you form an LLC or C Corp, your tax situation will be different than those for independent contractor taxes.
Purchasing office supplies
All of the items you use to run your business could increase your self-employment tax deductions. You would be surprised what you can get away with here. Everything from pens and staples to paper and postage can be written off.
Make sure to deduct the cost of office supplies that were used during the tax years.
For more expensive items like computers and special equipment, you can deduct them in the year you purchased them if their useful lives are under a year. If their useful lives take longer than a year, the IRS may treat them as assets that depreciate over time.
Depreciation of office supplies and equipment
As an independent contractor, it’s very likely that you purchased office supplies and equipment for business-related tasks. Over time, those items will lose value. For example, a scanner you purchased two years ago is worth lesser than when you bought it. That’s known as depreciation.
According to the IRS, if business-related expenses last for over a year, you can write off the depreciation of their value on your tax return. Repairs on property used for your business can also be deducted.
Note that these purchases should be made for business purposes only, not personal
Office supplies, such as printers, should be not be used for personal purposes. This distinction is important because an audit by the IRS may decide that supplies are non-deductible if you can’t prove they were used as a business expense.
Business equipment that can be used for both personal and business purposes can be called ‘listed property.’ In this case, you can deduct the percentage of the cost of business equipment, provided you can prove they were used for work.
If you are buying supplies for products you sell or manufacture, including shipping and packaging supplies, their tax treatment is handled differently for accounting purposes.
Supplies for making, packaging, and shipping products may be counted as inventory and are a part of the Cost of Goods Sold calculation.
Occupational operating expenses
The cost of advertising your services or products would also fall into this category. Web hosting fees and the cost of internet services are also operating expenses.
If you work from home, you can have a shared internet account for both business and home use and deduct a portion of the monthly cost for business purposes, or you can have a separate business account (this is recommended because it avoids the challenges of allocation use between business and personal). The same applies to other utilities such as a phone line.
Another potential write-off is the use of business cards because they also fall under occupational operating expenses. Make sure to keep internet expenses in mind when paying taxes.
Are you using your cell phone for both personal and business uses? If so, you can write off a percentage of the bill paid for cell phone services. Like your home office, you must determine the percentage of the phone bill used for business. This amount can be shown on your 1099 form.
Food and business entertainment
One tax write-off that often gets ignored is the cost of providing yourself with food and coffee while working. After all, all workers – employed or otherwise – need sustenance. For tax years after 2018, all food is 50% deductible. For 100% deduction, the expenses must be made available to the general public or used for arranging recreational activity for the benefit of the employees.
In general, expenses incurred for business entertainment cannot be deducted. However, you may be able to get tax benefits for some of the entertainment if there was food included in the price of a ticket.
This will increase the amount of bookkeeping you’ll need to maintain as proof of the deduction.
Child care as business expense
As an independent contractor, you can offer your employees up to $5,000 in dependent care benefits. For example, you can list your spouse as an employee and deduct $5,000 for child care for your own children. These benefits are not part of your wages. Hence, they can be deductible for you as an independent contractor. Dependent care benefits are tax-free for employees, even if the employee is related to you.
The expenses used up for cleaning your home office can be cited as a deductible. A cleaning company, janitor, or maid service can be used. If you have a family member interested in earning a wage, you can pay them to clean your home office. It is important to pay them a reasonable compensation for the work done.
One major benefit of hiring a relative is that you can contribute to an IRA for them based on their wages.
The financial repercussions of a potential mishap can easily wipe out the assets of a small independent contractor. This necessitates the use of business insurance to soften the blow that self-employed persons must shoulder due to mistakes.
Professional liability insurance, for example, can cover expenses if a client accuses you of failing to meet deadlines or making a mistake that costs them money.
In some cases, clients may want to see your insurance before signing a contract with you. You can include expenses for business insurance coverage in your 1099 tax form.
Hiring a tax adviser
As an independent contractor, the cost of hiring a qualified tax accountant may seem like an unnecessary expense. However, this professional can optimize your taxes and identify opportunities for massive potential savings when filing your 1099 form for income tax deductions.
The best part is that you can write off their fees as a business-related expense.
The cost of setting up shop
You may be able to deduce expenses you used for the cost of going into business, which are known as ‘start up costs’. They often include the costs of getting your business up and running before it opens, such as advertisements, salaries and wages for employees, and traveling to obtain suppliers, and hiring consultants.
You can deduct up to $5,000 of business startup costs and $5,000 of organization costs. These costs are treated as capital expenditures, which means they will be taxed as assets rather than expenses. This means you may be able to depreciate your startup costs over time, which can be written off as a deductible business expense. However, not everyone may qualify for this tax deductible.
For more information, check out the IRS Publication 545 guide for rules on any tax deductible that is applicable for you.
Wrapping up – Pay taxes the proper way
As an independent contractor, you can qualify for many tax benefits – just make sure to do your own research when estimating tax payments. It is recommended to hire a qualified tax planner to reduce your estimated tax payments while ensuring you stay on the right side of tax codes for federal income taxes (which is important if you want to minimize any tax penalties).
Part of the tax write-offs is the need to maintain detailed records for the IRS to audit. This can save you from potential tax penalties and maximize your tax savings.