Planning to leave your traditional 40-hour work week behind and join the "gig economy"? You're about to embark on a modern adventure in flexibility and taking command of your own life.
But, it comes with some new challenges. The effect of freelancing on your income taxes, for example, may come as a surprise if you're not prepared. So, here's a short guide to your new tax situation.
The Biggest Differences
As an independent contractor instead of an employee, you will see a few changes when filing taxes each spring. The biggest of these is that you file Schedule C, Profit or Loss from Business. Schedule C essentially treats you as a business, with gross income and business expenses to deduct. Your final profit after these expenses is what will be reported on Form 1040.
Aside from Schedule C, the second largest difference most independent contractors notice on their taxes is the addition of Self-Employment Tax. This tax applies to your business profit only and takes the place of FICA (Social Security and Medicare) taxes withheld from employee wages. In 2017, this tax is 15.3% and is not reduced by nonrefundable tax credits.
What You'll Need to Do
Once you understand how non-wage income changes your tax return, you can learn how to deal with those changes successfully. How?
First, you will need to keep a careful record of all income earned from any independent or freelance work. If you participate in more than one type of gig or use a different business name for any particular work, you may want to separate records for each.
Along with maintaining income records, be sure to keep track of all expenses related to your business work. This includes things like mileage for any trips, use of part of your home to do work, and costs of supplies and required fees. If you're not sure if an expense is deductible, keep it to discuss with your accountant at tax time.
You may also have to pay quarterly tax payments to ensure that your tax bill is covered at the end of the year. You generally may use last year's tax bill as a guide of how much to pay, but it's a good idea to consult with your accountant to determine the correct amount as well.
Finally, because you're not able to rely on employer benefits, you should consider starting an Individual Retirement Arrangement and research alternative ways to get covered by health insurance (especially if the tax penalty for not having insurance is significant).
By preparing yourself to handle the tax consequences of participating in the gig economy, you'll help ensure a smooth transition and a more successful foray into this new world of income.