“The best part about being an independent contractor is saving for taxes!” (Said no one ever.)
Undoubtedly, working as an independent contractor has many benefits that draw people to the lifestyle. But saving for taxes isn’t usually high on that list. Especially if you’re accustomed to a typical W-2 situation in which taxes are withheld from each paycheck, starting a 1099 lifestyle can feel like a rude awakening.
Even seasoned 1099 professionals often have plenty of room to refine their tax preparation process.
Here are some things you need to know:
Self-employment Tax
As a self-employed person, you are considered both the employee and the employer in the eyes of the IRS. That means that on top of federal and/or state income tax, you are responsible for the Medicare and Social Security taxes that most employers pay and are automatically deducted from W-2 paychecks. Medicare and Social Security taxes add up to 15.3% of your earnings.
Quarterly Taxes
To add another note to what is quite possibly the most common refrain on this blog: pay your quarterly taxes!
Depending on your circumstances, there may even be a penalty involved if you don’t. But, at the very least, it keeps you from getting slapped with a huge tax bill in April.
How much should you pay?
This article from Everlance advises a four-step process:
- Calculate your expected taxable income.
- Calculate your adjusted gross taxable income. (Subtract deductions/credits from the number you got in step #1.)
- Calculate the amount of taxes you owe based on your adjusted gross income. (This is your income tax, not the 15.3% self employment tax, which is based on your net income, not the adjusted gross income.)
- Divide your total estimated tax by four –– that’s your quarterly payment.
If math isn’t your thing, there is an even easier way. This handy 1099 calculator helps you determine the amount you’ll owe yearly based on your projected salary. Then you can divide that number by four to find the amount you should pay quarterly.
More information and the link to file can be found here.
Save Save Save!
But how much? On top of the 15.3% self-employment taxes, you’ll need to save for income tax on a federal and potentially state level. (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Washington, and Wyoming don’t have personal income tax on a state level.)
Most experts recommend saving 25-30% of each paycheck for taxes. What you actually owe will depend on your income bracket and your deductions, but this percentage should have you covered. If you live in California or Hawaii, the states with the highest state income taxes, you may want to add a bigger margin.
This article from Glassdoor provides additional information.
Keep Excellent Records for Deductions
What is deductible? That depends on your business and where you conduct it. This updated list from NerdWallet can answer your questions. When in doubt, keep a record. You’d rather have records of something that wasn’t deductible afterall than not have records of something that could’ve counted significantly towards your adjustable gross income! Your CPA can help you determine whether or not something is deductible based on your business.
Want to make things oh-so-easy for your accountant? This YouTube video gives step-by-step instructions on how to track deductions and how that affects your taxes, which will make you rise to the top of your CPA’s list of favorite clients.
Don’t have a CPA? It is very possible to do your own taxes as a 1099 contractor, especially if you have a steady gig and only file one Form-1099. However, most long-term freelancers agree that hiring a CPA is a great idea. Although there will be a fee involved, it is often not more than paying for the self-employment version of filing software such as TurboTax. Plus, the accountant’s expertise may end up saving you money in the long run!