Nearly half of adults in the U.S. have worked as an independent contractor or “gig worker" at one time during their career, according to MBO Partners' State of Independence 2020 Report.
Gig work may include driving for a ridesharing service like Uber or Lyft, or providing specialized consulting or business services, though it's not just for side hustlers or workers in between full-time jobs. Today, many experienced professionals seek the variety and flexibility offered by contract and project-based gig work.
Yet many independent contractors are surprised to discover that freelance work makes them small business owners in the eyes of the IRS. Being your own boss can get complicated when you need to start making estimated tax payments, tracking income and expenses, and filling out different forms and schedules with your tax return.
The following tax dos and don'ts for gig workers can help.
Do: Set Aside Money for Taxes
In the U.S., federal income taxes are a “pay as you go" system. When you work for someone else, your employer withholds taxes from your paycheck and sends them to the IRS on your behalf. As a self-employed person, you're required to estimate your tax liability and send estimated payments to the IRS four times per year: April 15, June 15, September 15, and January 15 (for the 4th quarter).
If you don't make estimated payments (or have enough tax withheld from another job to cover your gig work income), you could end up owing a lot of money when you file your tax return.
Unfortunately, estimating the amount you owe isn't simple. It depends on your tax bracket, the types of income you earn, and the deductions and tax credits you're able to claim. A good rule of thumb is to set aside 25% to 30% of your self-employment income for taxes. If you want to develop a more precise estimate of how much you owe, a tax professional can help you work through the calculations.
Don't: Forget About Self-employment Taxes
When you receive a paycheck, your employer withholds Social Security and Medicare taxes (collectively referred to as FICA tax). Self-employed people pay FICA taxes as well in the form of self-employment taxes.
In addition to income taxes, your self-employment income is subject to self-employment tax at a rate of 15.3%. The good news is that 15.3% is included in the 25% to 30% rule of thumb mentioned above. You pay estimated self-employment tax four times per year, on the same schedule as estimated income taxes.
Do: Open a Business Checking Account
Keeping your business and personal finances separate is crucial. The best way to do that is to open a separate business checking account and run all business income and expenses through that account. Not only does having a separate business checking account look professional, but it also makes it easier to track business expenses.
At the end of the year, it's easy to claim every available tax deduction because they're all on your business checking account statements. Otherwise, you'll waste hours sorting through receipts or picking business deductions out of a bank statement full of personal expenses.
Don't: Forget to Save for Retirement
Gig workers may not have access to an employer-sponsored retirement plan, but that doesn't mean you don't have options for saving for retirement.
Self-employed people have a variety of retirement savings options, including:
- Individual retirement account (IRA)
- Simple IRA
- Individual 401(k)
- Defined benefit plan
Each retirement savings option comes with its own contribution limits and rules. It's a good idea to work with an accountant or financial advisor who can help you choose the right option based on your financial situation and goals.
Do: Track Your Mileage
Deducting the miles you drive for business can be a valuable tax break for many gig workers. Even if your work doesn't involve driving for a rideshare service, you may use your personal vehicle to run business errands, meet with clients, or attend business networking events.
However, claiming a deduction requires keeping track of business miles and personal miles. If you don't keep track of those miles throughout the year, you have no way to accurately calculate your deduction when you file your tax return.
Fortunately, there are several ways to record your business miles. You can keep a logbook in your car's glove compartment or use an app like MileIQ to track miles for you.
Don't: Deal with Taxes Alone
Bring self-employed brings a whole new level of complexity to filing your tax return. That's why it's a good idea to work with a certified tax professional who can help you track your business income and expenses and claim every available tax break.
If you're used to handling taxes on your own, it might seem like working with a tax pro would be cost-prohibitive. But a good tax professional doesn't just help you file your tax return. They can also provide valuable advice to help make your business more tax-efficient and lower your tax bill. That kind of guidance can eventually pay for itself.