The Right Amount at the Right Time
Filing and paying your taxes looks a lot different as an independent contractor than it does as an employee. Let’s talk about how a contractor calculates their income and tax due, and then we’ll go over the timing of how a contractor should make tax payments.
Contractors have a much easier time deducting work-related expenses than employees do; in fact, starting in 2018, most employees can’t deduct unreimbursed work expenses at all. A contractor can deduct unreimbursed expenses directly against the related income on Schedule C, and only pays income and self-employment tax on the net income amount. Here are some expense items you can likely deduct:
Most contractors work from home. If you have a part of your house you use to conduct your work as a contractor, you can deduct a portion of the expenses of your home. You can either deduct a flat $5 per square foot (Line 30 of Schedule C), or you can deduct expenses based off the square footage of your office versus the square footage of your home (Form 8829.) Expenses you can allocate in this manner include mortgage interest, real estate taxes, rent, insurance, utilities, repairs and maintenance, and HOA fees. You can also depreciate your home for this purpose and deduct that as a home office expense; see Part III of Form 8829.
You can deduct the expenses of setting up and maintaining an office. Your computer and accessories, software, pens, paper, and other typical office expenses are deductible.
You can deduct a portion of your cell phone and internet bills for the percentage you use them for business. Be reasonable; the IRS can require you to substantiate the percentage you have chosen.
If you have a professional license, you can deduct your annual license fees. Whether or not you have a license, you can deduct costs you spend on continuing education, books, and other materials that help you expand your skills related to your contracting job.
If you have to make unreimbursed travel, you can deduct plane tickets, hotel rooms, and 50% of the cost of your meals while you are away from home. You can also deduct driving - for 2018, it’s worth 54.5 cents a mile.
The items above aren’t an exhaustive list. The legal standard for a deduction is whether or not it is an ordinary and necessary business expenses - as in, would a reasonable person consider the expense in question? If you have big items you’re not sure about, talk to a CPA and get some extra wisdom.
Contractors pay two different types of tax as part of their annual Form 1040 filing. One is the standard income tax, the same as everyone. The net business income is added to other sources of income (W-2s, interest, dividends, rents, etc.) as part of the calculation of taxable income. The second is the self-employment tax, which is a replacement for both the employer and employee portions of the Medicare and Social Security taxes paid by employees. The self-employment tax is a flat 15.3% on net self-employed business income up to $128,400 for 2018, and 2.9% on amounts above that. This tax is added to your income tax to determine your total tax liability.
Since there is no withholding done when payments for services are made, a contractor has to make tax payments directly to the IRS. Generally, the IRS requires that payments be made in quarterly installments through the year, which are called estimated tax payments. You must pay the lesser of 90% of your current year tax, or 100% of your prior year tax (110% for people with prior year adjusted gross income over $150,000) in four equal installments throughout the year to avoid the estimated tax penalty. The penalty is currently 6% (adjusted for changing ainterest rates) on the daily outstanding underpaid balance, so if you have to choose between paying the IRS or paying off credits cards or other short term debt, the IRS can usually wait.
Any amounts not paid in as estimated tax payments need to be paid by the April 15 filing deadline. Even if you get an extension, an extension of time to file is not an extension of time to pay. Amounts not by paid by April 15 will incur a penalty of 0.5% per month of the underpaid balance, plus interest, so try to pay what you owe by the deadline.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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