Tax Planning for 1099
You are probably an independent contractor if you are self-employed or a freelance worker. The IRS considers someone who performs work for someone else, and controlling the way that the work is done, as an independent contractor. Tax planning for an independent contractor could look a little different.
In short, as an independent contractor, someone pays you to perform a service or provide a product, but you have complete control of the final version of your service or product. As it pertains to taxes, an independent contractor has unique responsibilities. It is vital that you fully understand the guidelines for filing and paying taxes to prevent problems from arising with the IRS.
How to Qualify as an Independent Contractor
The main aspect of an independent contractor is keeping control of how their work is being performed. You have the status of an independent contractor if you work as a sole proprietor, form a limited liability company, or LLC, or adopt a corporate structure. The distinction for an independent contractor is that you are not classified as an employee.
How Income is Paid & Reported as an Independent Contractor
As an independent contractor, you have the power to determine when and how you are paid for your services or products. Because the vendor does not deduct taxes, your payments are not classified as a salary or wages for tax purposes. Be aware that both Social Security taxes or Medicare taxes are taken out from your compensation before you receive the money.
Once tax season arrives, the payer must provide you with a Form 1099-MISC that reports all of your income they paid you during the previous calendar year. The Form 1099-MISC is in lieu of a W-2, which is what employed workers receive from their employers.
However, if you earned less than $600, you still need to report the income, but the payer doesn’t need to provide you with a Form 1099-MISC. You will receive this form from each person or vendor that you worked for during the previous calendar year. Payers are mandated to have these forms completed and postmarked by the end of January every year.
How an Independent Contractor Pays Taxes
As an independent contractor, the IRS considers you a self-employed person. So, you are subject to a different set of tax payment and filing rules than employees. If your net earnings from self-employment are $400 or greater, you must file a tax return with the IRS. In addition to a Form 1040, you will file a Schedule C to determine your net income or loss for your business. If you have less than $5,000 in business expenses, you can file a Schedule C-EZ form.
You are also required to pay self-employment tax, which covers the total amount of money you owe for Social Security and Medicare taxes for the last year. The self-employment tax rate is 15.3 percent for tax year 2021. You are able to calculate your self-employment tax by utilizing Schedule SE on Form 1040.
Since tax year 2013, an additional 0.9 percent Medicare surtax applies to high-income earners. For the tax year 2021, the Medicare surtax applies to single filers and heads of household whose income is in excess of $200,000, married couples filing jointly whose income is more than $250,000 and married couples filing separately with income of $125,000 or greater.
If you anticipate that you will owe the IRS $1,000 or more in taxes, you will need to make estimated quarterly tax payments. These payments include your self-employment tax and your income tax liability for the past year. You could face a tax penalty if you do not make these quarterly payments or if you under pay.
Deductions decrease your taxable income for the year, and if you are an independent contractor, you are able to claim them as business expenses on your taxes. Based on the type of business you own, your deductible expenses could include the following:
- Legal expenses
- Business insurance
- Rent or lease payments
- Advertising costs
- Vehicle-related expenses
- Home office expenses
- Equipment purchases
As an independent contractor, you can also claim a deduction for health insurance premiums that you pay out of pocket. These will include premiums for dental, medical, and long-term insurance. You might also be able to deduct the costs of your spouse’s and children’s insurance.
There is an exception to this rule, which is that you are not permitted to deduct premiums for health insurance if you have access to a spouse’s insurance plan.
Additionally, independent contractors are also able to deduct personal expenses like mortgage interest paid, interest paid to student loans and real estate taxes. You could also enjoy a tax break for contributing to a self-employed retirement plan or a traditional IRA.
With respect to retirement, a few retirement plan options include a SIMPLE IRA, SEP IRA, or a solo 401(k). These plans allow for deductible contributions, with qualified withdrawals taxed at your ordinary income tax rate in retirement.
Tax Tips for Independent Contractors
- Make sure you have a reliable record-keeping system for your business. Maintain accurate records of your business income and expenses. You could think about using an expense app to keep track of receipts, charitable donations, and other deductible expenses. Also, always review your 1099 forms to make sure they are accurate.
- You would be wise to look to the services of a financial advisor who can assist you in effectively handling your tax obligations as an independent contractor.
- A financial advisor who specializes in tax planning will help you lower your 1099 income taxes by harvesting your losses. This translates into being able to use your investment losses to decrease taxes on 1099 income.
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Our Provo, Utah Tax Planning Services are just what your small business needs.
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