Here's how to avoid penalties and maximize tax deductions
Brought to you by: Beacon
Share current LOB: personalbanking
If you're a consultant, freelancer or contractor, your taxes likely are more complicated than the taxes of someone who works for a single employer and has money withheld from each paycheck. Of course you're in good company: 17.7 million Americans are independent workers, according to a recent report.1
But while your taxes may be complex, you can take steps to help you avoid penalties and minimize the money you owe.
Budget for extra taxes Traditional employees split Medicare and Social Security taxes with an employer. However, if you're self-employed you pay both portions—to the tune of 15.3 percent of your total self-employment income. This extra tax is sometimes called self-employment tax, and it's a good idea to set aside additional money from each paycheck to cover it.
"For many people that's the biggest federal tax," says Stephen Fishman, author of Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants.
Pay quarterly estimated taxes If you earn enough to pay income taxes and you haven't had money withheld by an employer, you need to pay quarterly estimated taxes in January, April, June and September. To avoid an underpayment penalty, Fishman recommends paying 100 percent of last year's tax liability, or 90 percent of what you owe this year.
Save your 1099s Traditional employees are issued W-2s from their employers before filing their taxes, but a consultant or freelancer gets a different form called a 1099. Save this form for at least three years, and double-check the amount of income reported.
"That form is sent to the IRS, and they do check that against what you put on your tax return," Fishman says. "If the amount is incorrect, make sure you ask your client to file a corrected 1099."
Keep track of eligible deductions Business owners, including consultants and freelancers, can take certain tax deductions traditional employees can't. These business tax deductions can help reduce your tax bill, but you need to be sure to document them. For example if you drive your car for business, keep track of mileage using a mile log or a smartphone app.
"You can claim 56 cents for every mile you drive this year, or you can keep track of every nickel you spend on maintenance and gas, and deduct that based on the percentage of your car usage that was devoted to business," Fishman says.
If you use space in your home exclusively for business, you may qualify for the home office tax deduction. This is based on the percentage of your home you use for business. The IRS now offers a simplified option for determining the home office deduction, which may make it easier to crunch the numbers.2
Taxes don't have to be a headache for nontraditional workers. Keeping track of deductions and staying on top of quarterly taxes can help prevent issues with the IRS down the road.
1. "2013 MBO Partners State of Independence Report," MBO Partners, September 2013.
2. "Simplified Option for Home Office Deduction," IRS.gov, July 2013.
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.
Tax refunds are great, but you might get more bang for your buck if you adjust your withholdings to put more money back in your paychecks. Personal finance blogger Paula Pant shares tax strategies for those with traditional jobs and the self-employed.