As a freelancer, independent contractor, or consultant, you have a variety of tax issues to consider—including ways to trim your tax bill.
For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post.
Tax-saving opportunities for the self-employed
Many people are career freelancers. Others find themselves doing freelance work after a corporate downsizing or other job loss.
Although being a freelancer, consultant, or independent contractor provides a new set of tax issues to consider, it also offers you plenty of new ways to trim your tax bill.
If you are paid $600 or more for your work for any individual client, you should receive a 1099-NEC from your customer. If you receive payments through online payment services such as PayPal, you may also receive a form 1099-K. And, yes, the IRS gets a copy, too. Typically, you include Schedule C with your tax return to report the self-employed income—along with the deductions for your business expenses.
And 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 deduct one-half of that SE tax as an adjustment to income on Form 1040. And if you have employees or use independent contractors in your business, you will have to file W-2 or 1099 forms for them.
The American Rescue Plan Act of 2021 significantly reduced the reporting threshold associated with Form 1099-K for card payment processors, and third-party payment networks like Venmo and Cash App from $20,000 to $600. Beginning with tax year 2022, if someone receives payment for goods and/or services through a third-party payment network, their payments are required to be reported on Form 1099-K if more than $600 was processed during the year. This change impacts small and large businesses including those who are self-employed or have side-gig income, real estate rental income, sales of items (online garage sales, re-selling of tickets) or hobby income.
Don't miss these tax-saving opportunities:
Hire your spouse and get a tax break on medical insurance
Although self-employed individuals can deduct 100 percent of health insurance premiums paid for themselves, a spouse and dependents, the deduction is allowed as an adjustment to income on the 1040. This can reduce your income tax but does not reduce your SE tax since it does not reduce your SE income.
However, if you hire your spouse and you provide family health insurance coverage to employees then you can be covered on your spouse’s policy. The cost the insurance for employees is deducted on Schedule C, and reduces your SE income and tax.
Set up a home office and maximize your write-offs
If you regularly and exclusively use a portion of your home or apartment or use a separate structure not attached to your house as your principal place of business or as a place to meet with clients, you can claim deductions for using the space.
Your office qualifies as a principal place of business if you use it as the sole place 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. The amount of the deduction depends on the percentage of the home or apartment that is used for business. The write-off is claimed on Form 8829, and is deducted on Schedule C. Thus, it reduces your SE income and tax.
Open a retirement plan to shelter your business profit
The most common self-employed retirement plan is a Simplified Employee Pension plan (SEP). You can put in up to 25 percent of your net earnings from self-employment, which is your net Schedule C profit minus the deduction for one-half of your self-employment tax. The maximum annual contribution for 2021 is $58,000.
Compare that to the $6,000 cap on IRA contributions ($7,000 if you are 50 or old at year end) for 2021. A SEP can be established for 2021 as late as April 18, 2022, or if you filed an extension, October 15, 2021.
Hire your children
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, as long as the compensation is reasonable for the type of work performed. Wages paid to the children are exempt from Social Security tax if they are under 18 and are not subject to federal unemployment tax if they are under 21.
In addition, unless the child has a lot of unearned income, chances are that he or she won't owe income tax on the wages. This lowers the family's tax bill considerably by moving taxable income from the parent to non-taxable income of the child. Also, a parent can make a contribution to an IRA or a Roth IRA for them based on their wages. Over time, this can grow into a nice nest egg for their retirement.
Deduct your mileage
Employees are not allowed to deduct the cost of driving to and from home to work. But if you are self-employed and your home is your principal place of business, you can deduct the cost of driving from home to see a client or to go to another work location.
You can claim 56 cents per mile for 2021, plus the cost of parking and any tolls you paid. Be sure to keep a record of your business driving or the IRS can deny your deduction on audit. For the first half of 2022 the rate is 58.5 cents per mile and increases to 62.5 cents per mile for the last half of 2022.
Combine business with pleasure when traveling
If you fly on a business trip to another U.S. city and spend a few extra days there as a vacation, you can deduct 100 percent of your airfare as long as the number of days spent on business is more than your vacation days. In other words, the main purpose of the trip must be for business. Your other out-of-pocket expenses, such as lodging, hotel tips and 50 percent of meals, can be deducted for the business days only.
Expenses for the personal days generally are not deductible. There is an exception if you spend an extra day or two away to get a cheaper airfare for a Saturday night stay over. If your added cost of meals and lodging for that period don't exceed what you saved in airfare, those costs (the hotel bill plus 50 percent of meals) can be deducted as business expenses.
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