Independent contractors vs. taxes: Set yourself up for success
Working as an independent contractor comes with many freedoms, but paying taxes is trickier than paying as a W2 employee. You must file additional forms, keep track of every business expense, and pay your fair share of taxes to the federal and state governments.
Add this all up, and you have the recipe for a stressful tax season. You’ve done your research but still feel anxious about tax season? Then this article is for you because
we want to help you set yourself up for success.
Start early - part 1: First steps
Working for yourself increases the amount of record-keeping you must do for tax purposes. It’s no fun digging through boxes of receipts and scrambling through credit card statements to pull together your finances. When you fall behind on tracking, you may envy your W-2 friends, who have it easier during tax season.
One way to remedy this is by starting early. The more complex your return, the earlier you should start. If this is your first year claiming self-employed income on your return, then you should get an ample head start.
What does starting early look like?
Step 1: Compile all your documents and identifiers like your SSN, tax ID numbers, and earning statements.
Step 2: Start tracking your finances for the previous year ASAP. If it’s February 2023, you should already have your finances for the previous year tracked. This gives you ample time to meet the April 15th deadline.
Step 3: Develop a system to automate as much of your record-keeping as possible. Ideally, you should track your finances monthly or weekly instead of waiting until the following year. One, there are a lot of unwanted expenses you can miss through that time. Two, you may owe quarterly estimated taxes.
Start early - part 2: know your deductions
Don’t be shy about claiming deductions that are available to you. A mistake many self-employed folks make is waiting until late March or April to track their deductions. You want to get ahead of the money-saving deductions and credits you have at your disposal. The IRS allows independent contractors to deduct work-related indirect and direct expenses.
- Direct Expenses: Direct expenses are necessary to complete your work, like supplies, business services, or postage.
- Indirect Expenses: Indirect expenses are not directly related to your work but are incurred as part of your job, like utilities and home insurance.
If you travel as part of your work, you can also take deductions outside the home. Keep track of your mileage, food, and lodging expenses for work-related travel. Not all of these expenses are 100% deductible, so work with a tax professional if you need guidance.
Lastly, there are a few “outside the box” deductions that often get overlooked by independent contractors. If you pay for your own health insurance, you may be able to deduct your premium. If you’re self-employed, it’s up to you to improve your skills to increase your income. The IRS recognizes this and allows you to deduct educational expenses directly related to your existing business.
Make saving non-negotiable
One of the biggest stressors independent contractors face is not having enough money saved come tax time. Your eyes may get bigger than your wallet since you don’t have an employer taking a chunk out of every paycheck.
If you’re not careful, you can create a cascade of penalties and interest that can hurt your business. If you don’t have enough saved to pay your taxes, then you definitely won’t have enough for the penalties.
There’s no set amount you should set aside each month, but ideally, your savings account should grow each month.
Don’t forget your estimated taxes
We’d venture to say that most new independent contractors have no clue what estimated tax payments are. Independent contractors must make quarterly payments to the IRS because they’d rather have their money now rather than later. As an incentive, if independent contractors don’t pay 90% of what they owed in estimated payments throughout the year, then when they file their annual returns, they will owe an underpayment penalty.
Here are the payment due dates for estimated taxes according to the IRS.
January 1 – March 31
April 1 – May 31
June 1 – August 31
September 1 – December 31
January 15 of the following year
Let’s face it, there’s a lot to self-employed taxes. It’s okay to admit that you’ll never be a tax savant and use e-filing tools to do the job. There are enough deductions to make your head spin. You could spend hours looking for deductions, but that just takes you away from your work. In essence, you’re losing money in the pursuit of saving money!
What to look for in online tax software:
- Tax deduction finding tools
- Tools to help you file with your state
- Customer service for individual service
- Accuracy measures and a maximum refund guarantee
Have a routine
It’s likely that you already have a routine for your day-to-day business operations. Experiment with a tax-season routine. For example, you could spend 15 minutes daily working on your taxes in the morning. Or, if you’re more comfortable working in longer sprints, spend 1-2 hours once a week.
Manage the fear of the unknown
If tax season sends a spike of cortisol through your body, maybe you have a fear you need to confront. The honest citizen in all of us wants to pay your fair share of taxes. However, the business owner in us wants legally to save as much money as possible. In the middle, you have IRS, your proverbial boogeyman. There’s just one thing our brains tend to get wrong…
The IRS is NOT out to punish you.
You may qualify to have certain penalties removed or reduced if you acted with reasonable cause and in good faith. This is not legal advice, but don’t fear prosecution or business ruin if you owe the IRS money. Yes, they will penalize you, but only to inspire you to make proactive decisions in the future.
Get the most out of being an independent contractor
A recent study found that as many as 32% of self-employed professionals don't report all of their income to the IRS, and as many as 36% confess to not filing any taxes at all. Do you lack confidence during tax season? And did you find this article helpful? If so, you should consider the tools ComplYant has available to help independent contractors like you.