Filing tax returns is difficult enough for typical workers, who start with the relative simplicity of the standard W-2 form issued by their employers.
But the fiscal rites of spring are even more complicated for people who work for themselves or have a business on the side that generates extra income.
Recently they’ve been joined by independent contractors in the so-called gig economy, such as Uber drivers, Amazon delivery people and homeowners renting out space on Airbnb.
They’re all part of what’s become known as the 1099 economy, for the Internal Revenue Service form showing payments to workers who are not employees.
Recipients of 1099 forms must take additional steps in calculating their incomes and figuring out their tax payments, including deducting eligible expenses.
Donald Hance, president of Glenmore Financial Inc. in Los Angeles, helps independent contractors file their taxes. He recently discussed the challenges and offered advice. Here’s an edited version of the conversation.
Q: Why do some workers receive 1099s instead of W-2s?
A: They’re considered contract employees when they get 1099s. Usually it’s a temporary assignment or sporadic work that they have. The worker’s going to be responsible for reporting the income and paying the full Social Security and Medicare taxes on that. When you’re an employee and get a W-2, the company pays half of the Social Security and Medicare taxes.
Q: Payroll taxes that cover Social Security and Medicare usually are split between employers and employees. But that’s not the case with independent contractors, who must pay a self-employment tax. What are the tax implications?
A: You pay half (the payroll taxes due) and you get a credit for half of that as an adjustment to your income. So you do get a little sympathy from the IRS for the half of the taxes that you’re paying. What’s really important is that you are keeping track of your expenses. Anything related to generating that income can be used to offset that income. That will bring down your gross income and bring down your Social Security and Medicare taxes.
Q: What are some types of expenses that can be deducted?
A: Anything that’s ordinary and necessary to carry on your business.
Typically there’s travel, entertainment and vehicle expenses. Those are often used by most self-employed businesspeople.
The business portion of the house that you’ve got dedicated to generating the income, that percentage of the square footage that’s used only for business, you can deduct a percentage of those expenses.
If you’re self-employed, you should keep track of it throughout the entire year. It’s hard to keep track of things retroactively, particularly mileage on a car. You want to know what your beginning mileage is Jan. 1. Any time you’re driving for business, you should be keeping track of that.
The more detailed or specific your documentation is, the better. Mileage on an automobile is always a gray area. It’s kind of your word against the IRS on how much you’ve driven for business vs. pleasure. (Tip: Get your vehicle serviced near the start and end of the year so the records will include your odometer readings.)
You want to be well aware of all the eligible expenses, particularly those that might be unique to your work. (The instructions for IRS form Schedule C contain information on eligible business expenses.)
Q: What about health insurance?
A: It’s actually an advantageous deduction for self-employed people. You can write off (premiums) as an adjustment to your income, as opposed to an itemized deduction, in which you may not get as much benefit. There are limitations, depending on how much income you earn.
Retirement contributions also are deductible. If you’re self-employed, you might be able to write them off, depending on your income and your plan.
Q: Self-employed people need to make quarterly estimated tax payments to the IRS throughout the year. How do you handle that and what if you fail to do that or to pay enough each quarter?
A: When you settle up with the government April 15, you get an under-settlement penalty. Ideally, if you pay as you go each quarter, adjusting if your income fluctuates, you won’t pay a penalty.
When I do a client’s tax returns in March or April, I ask them, “What does it look like for this year? Is (your income) going to be higher or lower?” We give them an estimate and tell them they need to send in a payment quarterly.
Q: What if you receive a W-2 from your main employer but also get income from a side job, such as driving for a ride-hailing service or renting out a room on in your home? Can you take the same deductions?
A: Anything that you’ve got as a side business generating income, looking at all the expenses you can use to offset that income, we would operate the same way. If there’s net profit, you still pay Social Security and Medicare tax payments.