The number of people filing Schedule C tax documents grows each year, surpassing 28 million people in 2023. With more independent contractors, self employed, in the U.S. than ever before in history, understanding the tax laws for gig workers is more important than ever.
Whether you already work as an independent contractor or you’re considering taking on a side gig for extra cash to cover your bills or pay down debt, you should know what to expect when tax time rolls around.
What Is an Independent Contractor?
An independent contractor is a worker who is not on a company’s payroll, but completes some sort of task or job for a client or, in many cases, multiple clients, on a short-term, contractual basis. Independent contractors range from people like drivers for DoorDash to many doctors, lawyers, and other professionals.
A self employed worker might refer to themselves as a business owner – but it is a business entity of one. (Hence, the word “self-employed.”)
To be considered a 1099 independent contractor in the eyes of the IRS, you must meet certain criteria.
Primarily, your client cannot control how, when, or where the work is performed. The client can only dictate the result of the work or the outcome.
Independent contractors typically provide their own equipment to complete the tasks they are paid for, and often work for multiple clients at the same time.
Clients do not withhold taxes from an independent contractor’s payment. The independent contractor is responsible for paying all taxes when they are due, including quarterly estimated tax payments. This lack of withholding taxes is one reason independent contractors may see a larger-than-expected tax bill if they aren’t educated about ways to reduce taxes as a freelancer.
Why Is My Tax Bill So High as a Freelancer?
Freelancers, gig workers, and sole proprietors understand the thrill. You have a record year, bringing in more revenue than ever before.
But when tax time rolls around, you realize you’re receiving a much smaller refund. Or, worse, you owe your state or the federal government thousands of dollars.
If you haven’t prepared for this contingency, it can affect your annual business revenue for next year, your current lifestyle, and even your mindset and attitude toward growing your business to its full potential.
To prepare the best tax strategy for your business moving forward, you need to know why your tax bill is high.
Self-Employment Taxes
All businesses incur a 15.3% Federal Insurance Contributions Act (FICA) tax to help fund Social Security and Medicare. Employers lighten the tax burden on themselves by splitting the cost with employees, which comes from each paycheck. Self-employed individuals are responsible for the entire amount.
Income Taxes
Income taxes are a tax imposed on individuals and businesses. If you work a W-2 job, you’ll pay a personal income tax. If you are an independent contractor, you pay a business income tax. And if you live in 42 out of 50 states (excluding Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming), you pay local taxes. Income taxes are considered revenue for the government and help fund public services.
You Failed to Make Quarterly Estimated Tax Payments
Whether you’re aware of it or not, you may have quarterly tax obligations to fulfill as an independent contractor. Whether you’re a freelancer or a W-2 employee, you must pay 90% of your taxes owed for the year before the end of the year. When Tax Day rolls around, typically April 15, your unpaid tax debt is the balance of tax you owe after any deductions or tax credits.
If you paid too much in taxes, you’ll receive a refund. Employees don’t have to worry as much about the Underpayment of Estimated Tax by Individuals Penalty.
Their employer takes out withholding taxes, which should cover 90% of the total taxes owed – and often, even more than that.
But independent contractors must pay those taxes themselves before the end of the year, which means estimating your income for the year and dividing the taxes you owe into four quarterly payments.
Of course, you can pay those taxes upfront for the year, or even wait and pay them all in December. But if you wait until April to pay, you’ll be charged penalties – even if you ultimately receive a tax refund.
As an independent contractor, you can avoid a potential tax bill by making those quarterly payments.
You’re Not Tracking Expenses
Deducting business expenses is one of the most popular and effective ways to reduce your tax bill. If you’re using software, buying new tech, or even putting gas in your car to get to gigs, you can deduct those dollar amounts to reduce your tax bill.
Be strategic about what expenses you deduct, though. Deducting too much can impact what kind of business credit you can get if you ever need it. And certain deductions raise red flags to the IRS, which can trigger an audit.
If you’re not sure what expenses are tax deductible, speak to a tax professional specializing in freelancers and independent workers.
It’s also important to keep records of your business expenses. Some contractors like to keep a specific debit or credit card devoted exclusively to business expenses. Those statements can act as proof of your business costs if you are ever audited. Various apps also exist that allow you to capture and store photos of receipts to track business expenses.
Ways to Reduce Your Tax Bill as a Self-Employed Independent Contractor
Several strategies can help you reduce your tax liability as a self-employed individual. Whether you’re filing your taxes or hiring a tax professional to help, the first step to a lower tax bill is understanding the tactics you can use now and in the future for tax savings.
Take Any Deductions You Qualify For
The IRS allows you to deduct certain costs from your adjusted gross income, which can reduce your overall tax liability. Deductions help in two ways:
- They reduce your taxable income, which may put you in a lower tax bracket, which means you’ll owe a smaller percentage of taxes
- They reduce the overall amount you owe
Since the IRS increased the standard deduction, roughly 90% of people claim the standard deduction, according to Forbes. This year, individuals can take a deduction of $13,850, while married couples, filing jointly, are entitled to $27,700.
However, independent contractors may find their itemized deductions far exceed this number. Take heed of your business expenses throughout the year – and keep track of them – to help reduce your tax bill.
Take the Tax Credits You Deserve
Tax credits, on the other hand, directly reduce the amount of taxes you owe. Typically, tax credits impact the bottom line more because they are designed to incentivize certain behaviors.
For instance, if you purchased an electric vehicle in 2023, you may qualify for a clean energy tax credit. Some tax credits require you to meet specific requirements or income thresholds, so double-check with a tax professional if you aren’t sure.
One of the first things we will do at Alleviate Tax to help reduce your tax bill is to make sure you took all the credits and deductions you were entitled to. If we find unclaimed credits and deductions, we can help you file an amended return.
From there, we will deal with helping you get out of tax debt through one of the many programs the IRS has available for tax debt resolution in 2024.
Audit Your Investments Annually
If you invest in stocks, ETFs, or mutual funds, review them regularly. The best time to offload low-return investments is the end of the year before tax season. Reported losses are tax deductible using a strategy called “tax-loss harvesting.”
You might want to speak to a financial professional to discover how to leverage this tip to minimize your capital gains tax on investments and reduce your overall tax bill.
Consider Charitable Contributions
If you’re itemizing deductions, which you probably should be as an independent contractor, you can also deduct charitable contributions made in your name or your business name. If you find yourself with larger than expected income from your business or side gig as the end of the year approaches, you can make the holiday season a bit brighter for your favorite organization.
Just make sure the organization you donate to is a registered 501(c)3 organization. These can include local churches, children’s sports teams in your community, educational facilities, scholarship organizations and more.
As a side benefit, making a charitable donation within your community can elevate your company’s standing in your community and generate positive publicity.
Lower tax bill? Free publicity? Feel-good vibes from giving back? Any independent contractor with some extra cash should say, “Yes, please.”
Invest in Your Retirement
Contributing to an individual retirement account (IRA) is another great strategy to lower your tax bill while doing something good for your future self.
Independent contractors typically can’t take advantage of 401(k) retirement accounts, which often include matching funds from the employer. But, you have another option that can help reduce your taxable income.
A self-employed IRA is similar to a traditional IRA or a 401(k) (minus that employer match, of course)!
When you contribute to a self-employed IRA, the income is deposited using pre-tax dollars. That means you can directly reduce your taxable business income, which lowers your tax bill.
Be aware that SEP IRA withdrawals are taxed, so you’ll want to account for that in your retirement planning strategy.
Need Tax Help?
With a little planning and smart tax strategy, you don’t have to accrue tax debt while you’re running a successful sole proprietorship. If it’s too late and you’re already facing a large tax bill you can’t handle, Alleviate Tax is here to help you like we’ve helped so many other independent contractors.
PPA
Find out what independent contractors need to know about self-employment taxes.
How can a 1099 contractor legally reduce taxable income?
Independent contractors must pay federal income tax the same as most other workers, along with self-employment taxes, which can increase the amount you owe. Fortunately, contractors can reduce their taxable income by deducting business expenses, itemizing deductions, and investing in a tax-deferred retirement account.
What business expenses are tax deductible for a 1099 employee?
1099 independent contractors can write off many business expenses, including business equipment and software, trainings that you pay for, and advertising or marketing costs.
What can I write off on my taxes as an independent contractor?
Independent contractors can write off business expenses, including a vehicle used for work, advertising and marketing costs, business equipment, retirement savings, and more to reduce their tax bill.
