Being a freelancer, consultant or independent contractor has its benefits, but having your taxes automatically deducted from your paycheck isnt one of them. While dealing with 1099s can certainly create more paperwork for you, it can also provide plenty of opportunities to lower your tax bill. Here are five tips for making April 15 as painless as possible when youre not a full-time employee.
- Know what to expect. If youre paid $600 or more by any individual client, you should receive a 1099-MISC from that client. For a sample, click here. Typically, you include Schedule C with your tax return to report any self-employed income – along with any deductions for business expenses. If your net earnings from self-employment exceed $400, you will have to pay self-employment tax for Social Security and Medicare – which is figured on Schedule SE. You then deduct half of that SE tax as an adjustment to your income on Form 1040. If you have any employees or hire independent contractors yourself, you will have to file W-2 or 1099 forms for them, as well.
- Pay your taxes quarterly. Traditional employers deduct and pay employee taxes to the IRS monthly, but not for independent contractors. Thats why indies are required to pay taxes on a quarterly basis – in April, June, September, and January – if their annual tax liability exceeds $1,000. An easy way to accomplish this is to save a portion of each paycheck in a separate tax account. Form 1040-ES is also a great tool for helping independent contractors calculate and make estimated tax payments.
- Work at home? Write it off! If you regularly use a portion of your home or apartment (or a separate structure not attached to your house) as your principal place of business, you can claim deductions for using that space. Your office qualifies as a principal place of business if you use it solely to perform administrative duties. Expenses that may be deducted include the business portion of real estate taxes, mortgage interest, rent, utilities, insurance, painting, repairs, and depreciation. How much you can deduct depends on the percentage of your home or apartment that you use for your business. The write-off is claimed on Form 8829, and is deducted on Schedule C.
- Shelter your business profits in a retirement plan. The two most common self-employed retirement plans are a Simplified Employee Pension plan and a Keogh plan. In either one, you can contribute up to 20 percent of your net earnings from self-employment, which is your net Schedule C profit minus the deduction for half of your self-employment tax. The maximum annual contribution for 2014 is $52,000, which compares pretty favorably to the $5,500 cap on IRA contributions ($6,500 if you are 50 or older). While a Simplified Employee Pension plan can be established for 2014 as late as April 15, 2015 (or if you filed an extension, October 15, 2015), a Keogh plan must be established by Dec. 31, 2014 to accept contributions for 2014. And if you have any employees, they may be eligible to have Keogh contributions made for them.
- Got kids? Hire them. Sole proprietors who hire their kids to do data entry, answer phones, clean the office, and perform other business-related activities can deduct their wages on Schedule C, provided the compensation is reasonable for the type of work involved. Your childrens wages are exempt from Social Security tax if they are under 18, and are not subject to federal unemployment tax if they are under 21. And unless your kids have accrued a lot of unearned income, chances are that they won’t owe income tax on the wages. This lowers your familys tax bill considerably by rendering taxable income from you (the parent) non-taxable when it goes to your children. Bonus: As a parent, you can make a contribution to an IRA (or a Roth IRA) for your kids based on their wages. Over time, this can grow into a nice nest egg for their retirement.
Remember to always consult a financial professional before making any changes to your portfolio. For more information, visit the IRSs Self-Employed Individuals Tax Center.