One of the most prominent trends in today’s economy is the rise in contract work, also known as “gigs”, “freelancing”, or “1099 work”. Whatever term is used, more and more people are working and supporting themselves with these kinds of jobs. However, many people don’t realize that income earned in these positions is subject to very different tax rules by the IRS than traditional wage income. As a result, there are a number of important items that contractors, new or old, should be aware of.
The deductibility of expenses. The IRS considers contractors to be running their own businesses, rather than being employees of other businesses. As a result, they are able to directly deduct their business expenses against their business income. Per the IRS, these deductible expenses include anything that is “ordinary and necessary” in earning the income. They can include anything from office supplies like pens and paper used in the business, to meals eaten with potential clients, to travel expenses incurred to get to a particular gig, to any number of other items. If you’re unsure of whether a particular type of expense that you pay for is deductible, you should contact an Melbourne tax accountant.
The deductibility of mileage. Most expenses are deductible by only by the direct dollar amounts paid. For example, if you pay for $30 in office supplies, you can deduct that same $30 as an expense. However, the IRS allows an additional option for auto expenses. While you can choose to deduct the business-use portion of your gas, auto insurance, auto repairs, and other upkeep costs for your vehicle, you can also choose to instead take a per-business-mile deduction. For 2015, the IRS’s allowable mileage rate is 57.5 cents per business mile. Choosing to deduct mileage requires you to carefully track the dates and purposes of your business mileage. However, this option is generally more beneficial than deducting a business percentage of your actual auto expenses.
The self-employment tax. Employees have payroll taxes, used to pay for Medicare and Social Security, taken out of their wage checks. However, contractors do not have these payroll taxes taken out. As a result, the IRS assesses the self-employment tax on contractors’ net incomes (the amounts they receive in their business minus their deductible expenses). For 2015, the self-employment tax is 15.3% on up to $118,500 in net income, and 2.9% on any net income beyond that amount.
The need for estimated tax payments. Employers withhold federal and state income taxes from their employees’ paychecks and pay the amounts to the IRs and to the state on those employees’ behalf. As a result, employees typically receive a small refund when they file tax returns. In contrast, contractors have no employer, and thus no one is paying income taxes in on their behalf. As a result, if no taxes are paid before annual tax returns are due, contractors can often end up owing more in taxes than they can pay at once. As a result, the IRS and states recommend that contractors pay in estimates of the income tax that they’ll owe each quarter over the course of the year. The IRS’s estimates are paid in through Form 1040-ES. Each state has a different estimate form, but Melbourne’s estimates are paid in on Form 500-ES.
These are only a few of the most general, basic items that contractors should be aware of. In order to get specific, customized advice for your situation, you should contact an Melbourne tax accountant.
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