Maximizing Your Tax Efficiency as a Self-Employed or Part-Time Gig Worker
More people than ever are working as freelancers—self-employed workers. It’s estimated that 78 Million Americans have participated in the ‘gig economy.’ Much of this is due to the explosion of Lyft and Uber business models, but a large portion can also be attributed to younger workers both preferring the independence of self-employment, and the lack of traditional career-track employment opportunities.
All this means, more and more people taking contract jobs and filling out 1099s. As a self-employed worker, you’re defined as both the employer and employee, you are required to pay the self-employment tax of 15.3% for your first $132,900 in income. Let’s examine various deduction strategies to help reduce your overall tax burden, and ways to ensure that you don’t get in trouble with the IRS
Your business expenses are practically guaranteed to be higher as a self-employed worker than if you worked for somebody else. Office supplies, including printers, ink, and business cards, can be written off. You can even deduct your laptop if over 50% of the time you spend on it is for business. For example, if your laptop cost $1,000 and you spend 60% of your time on your laptop for business and 40% for personal use, you can deduct $600. If it’s completely for business, deduct the entire cost.
Always consider if something you’re buying is appropriate to write off as a business expense. Up to 50% the cost of business-related food, like lunches, can be written off. The IRS rule-of-thumb is that basic expenses should be ordinary and necessary. In other words, if you would have purchased the item or service regardless of whether or not it helped your business, then it likely does not qualify.
Home Office Deduction
If you’re self-employed, there’s a decent chance you work from home. The home office deduction is one of the larger deductions available to you as a self-employed worker. You qualify for this deduction if there’s a specific area of your home designated as an office space. It needs to be used exclusively as an office space, so using a children’s playroom while the kids are at school is not allowed to be deducted (unless your home business is running a child day-care). The IRS allows you to deduct an office up to 300 square feet, giving you $5 per square foot. That’s a total of $1,500, if you have a 300sq.ft office space. At least, that’s what it looks like if you take the simplified home office deduction.
You could, if so inclined, go through the trouble of documenting all expenses related to your home office and create an itemized deduction. This includes the portion of your mortgage or rent that would be deductible, utility costs, and the costs of painting, repairing, and general maintenance. Generally speaking, the simplified home office deduction is preferable if you have a smaller home office with little maintenance or repairs being done. If you have a larger office with bigger expenses, and you have the time and/or money to keep (or pay someone else to keep) your expenses organized come tax time, then it may be worth it for you to do it the long way.
Travel for business is always deductible, as long as it’s really for business. Traditional workers, who work for an employer, are not generally eligible for deducting their commute, however other travel expenses are permitted. The same rules apply to 1099 workers. Airline tickets, baggage fees, rideshare costs, etc., are all deductible so long as they are in pursuit of your business goals. You cannot write off your vacation.
Hotel and lodging expenditures are also eligible to be written off, and 50% of all food expenses, regardless if it’s directly for business, are eligible so long as the trip itself was required for business, and it involves an overnight stay. Rental cars are also eligible.
You May Not Get A 1099-MISC From Every Client
Currently, under Federal law, a client is required to send you a 1099-MISC form at the beginning of the year is they paid you $600 or more. But what about those who paid you less than $600? Well, you won’t be getting a form from them, but the IRS still expects you to report that income. What’s important for you to do is to keep consistent, clear records of all the money you’ve been paid so that when it comes time to file, and you realize you won’t be getting that 1099-MISC, that you’re not scrambling through old bank statements.
- Freelancers who work with rideshare companies like Uber and Lyft will receive one 1099-MISC from their respective company, while those who work with multiple clients/companies may receive upwards of dozens of these forms.
- Some sites, like Upwork, will collect all relevant tax information in one place for freelancers who use their service so that you aren’t bogged down with paperwork.
Take note of any possible advantages available to you, you’ll be glad you did come tax time.
Healthcare Deduction for Self-Employed Workers
The United States may eventually join the rest of the industrialized world in having a universal healthcare system that’s run at a lower cost, but until then, healthcare premiums are a fact of life. The good news is, if you’re a self-employed worker, you can deduct 100% of your healthcare premiums. That includes coverage for you, your spouse, any dependents, and non-dependent children under 27. If you’re working full-time as a self-employed worker, there’s a good chance that health care costs are among the highest single area expenses you have, so this deduction can make a huge difference.
Be careful, though. You are not eligible for this deduction if you also work for a company through which you are eligible to receive coverage, or if you are eligible to be covered by a spouse’s company. And, you can only deduct what you’ve actually earned from your business:
- If you have a personal business, and you don’t have an employer that offers you insurance, and your personal business makes $5,000 per year, but your healthcare premiums are $6,000 per year, you can only deduct $5,000 of your premiums.
When you purchase your health insurance plan, you do so in either your name or the name of one of your businesses. The name you put is your plan’s “sponsor”. You can qualify for the healthcare deduction if you are your own sponsor. If you have multiple businesses, it would be wise to purchase your health insurance plan in the name of the business you anticipate to make more money, that way you can ensure a higher deduction.
Education, Training, and Certifications
If you want to expand your ability to do your job, one way to pursue that is to get further education, training, or a certification. All of these options are deductible come tax time. This is a perfect opportunity for someone whose educational interests are in-line with their current business. Beware, you can not write off education or training expenses for a career you do not yet have—it needs to be as a result of you furthering the business you already operate. For example, if you’re a private chef, you can write off culinary seminars and clinics with Gordan Ramsey. But if you’re a copyeditor, you can’t write off that cooking class.
Paying Taxes Quarterly
It’s a smart idea when working self-employed to pay your taxes quarterly, instead of at tax time like everybody else. When you work for a business, your taxes are withheld and sent to the state and federal government with each check, meaning you’re paying your income taxes throughout the years.
- As a self-employed person, it stands to reason that your total income year-to-year would be variable, so the numbers you submit to the IRS each quarter are estimates. If something substantial happens to your business, like you lost or gained a major contract, it would be wise to change your projections as soon as possible so that there are no tax surprises later on.
In fact, it’s more than a smart idea, it’s practically required if you’re making a significant amount of money. By the time taxes are due, most people are looking to see either how big their refund will be, or if they’ll owe a marginal amount to the IRS. But, if you’re self-employed, and you aren’t paying quarterly taxes, you will see the entire tax burden at once. Not a good sight.
Not only that, since you will have paid less than 90% of your total taxes, you will also have to pay a penalty for underpaying throughout the year. Some people find that it’s easier to manage their money and just pay the penalty, however this is naive and gives the government more money than they’re entitled. You can manage these quarterly payments online, and when April rolls around you simply pay the balance owed, or pick up your refund, just like everybody else. There are multiple tools available that make managing your money easy enough that you shouldn’t leave money on the table.
There are a lot of benefits to working for oneself. The freedom of being your own boss, and earning every dollar yourself, are reasons why more and more people are choosing self-employment. In today’s day and age, the technology available to us allows us to get away from traditional models of employment, and when there is opportunity, there is movement towards that opportunity. For those who are new to this style of work, I hope that you’ve learned how to better manage your expenses and have a better understanding of the tax structures surrounding self-employment.