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Tax Strategies for the Self-Employed and 1099 Contractors

Tax Strategies for the Self-Employed and 1099 Contractors

A businessman stresses out - yourmoneyvehicle.com

By Adrian Fernandez

“How do I make ends meet with this inflation? How can I make some extra money to save for that down payment? Would I earn more or have more freedom if I stopped working for someone else and started working for myself?” If you thought of any of these questions at some point, you’re not alone. 

The National Employment Law Project states that “10 percent of (American) workers are self-employed, but millions may be misclassified”. With the growing amount of self-employed workers, the “gig economy” is proving to be an increasingly desirable path, and it comes with nice tax incentives.

I wish I paid more in taxes!! -Not a single person I know. 

We all know that taxes are important to keep society working, but most of us also want to reduce how much in taxes we pay for one reason or another. If that’s the case for you and you’re self-employed or paid through 1099 rather than W-2, here are some strategies that have saved me thousands of dollars as a self-employed individual whose parents are both small business owners and who do the same. 

What if I am a 1099 contractor and I don’t know it? Do I need an LLC?

Getting a 1099 paycheck is different from the average W2 payment. It means that you’re not an employee and just provide products and/or services to whoever is paying you. Wondering why you’re not getting a tax refund? Getting a 1099 paycheck also means that your tax liability is not withdrawn from your paycheck monthly, instead you pay it at the end of the year. You end up paying the same amount anyway! If paying all taxes at once is an issue for your budgeting, you can set up a savings account for this that earns interest or set up tax pre-payments to the IRS during the year.

Since contractors are not employees, they get significantly fewer labor protections than those who are paid through W-2. How do you get some protections? Through an LLC. A Limited Liability Corporation is a business entity that’s easy to set up and provides major benefits such as categorizing many expenses as business expenses, which lowers your taxable income and thus lowers the taxes you owe. It also protects you from debt liability as well as if you get sued, since you can only be held liable for the amount that you invested in the business. You can set it up by going to your state’s division of corporations, paying a fee, and now you officially own a business!

Taxes: Friend or Enemy?

Just like you need to speak the language of money to make it and keep it for the long run, you need to speak the language of taxes if you don’t want to give away thousands of dollars. Are you going to make taxes your friend by understanding how to pay less of them, or your enemy?

There’s a plethora of information on irs.gov and other websites regarding how to correctly claim tax credits and business expenses so you can legally reduce your tax liability. Some examples of this are:

  1. Vehicle miles
  2. Equipment and business depreciation
  3. Self-employment tax deduction

1. According to H&R Block, a major player in the tax preparation field, “For the 2022 tax year (taxes filed in 2023), the IRS standard mileage rates are: 65.5 cents per mile for business. 14 cents per mile for charity. 22 cents per mile for medical purposes or moving purposes for qualified active-duty members of the armed forces.” 

1. How many miles do you drive a year? Since the average driver drives 10-15 thousand miles in a year, if you claim to use that vehicle for only business purposes, that’s $0.65*10,000 or 15,000: $6,550-$9,825 in tax savings! If you use it sometimes for personal use, a tax deduction is given based on how much you use it for personal vs. business use, as long as you use it for the business over 50% of the time. Ex: if you drive 10,000 miles and use your vehicle 80% of the time for business purposes, you are saving $5,240! Keep in mind that when I say business purposes, I mean any activity related to your 1099 job, like driving to obtain materials or going to see a client.

2. There’s also equipment and business asset depreciation. Depreciation is when an asset loses value over time. For example, when you own a construction business you own equipment like tools and machinery, and since it loses value over time, you can claim some of those losses as a tax deduction. According to irs.gov, other business assets work as well: ” You can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. You can also depreciate certain intangible property, such as patents, copyrights, and computer software.” 

3. You can deduct the employer-equivalent portion of your self-employment tax when you file your taxes, which lowers your adjusted gross income and thus income tax. More information on self-employment tax is below.

Self-employment tax

Self-employed people pay an extra tax rate of 15.3% because they include both the employer’s and employee’s Social Security and Medicare tax, besides the person’s federal, state, and local income taxes that everybody has to pay. W-2 employees pay 7.65%, or half of those FICA taxes (Social Security and Medicare) every month since they’re only liable for the employee’s portion of FICA taxes. 

Even if you can lower your income tax with the deduction, all of these taxes can add up to a sizable amount every year, oftentimes being almost or even half of your income, so make sure that you’re saving enough and are using the tax code to your advantage to make it less of a burden, all in a legal way! 

Since the self-employed pay their taxes once a year instead of every paycheck, budgeting for this can be challenging. It’s recommended that you use your favorite budgeting app or method for this and if setting aside hundreds of dollars every month for the annual Society Choice payment is difficult, consider opening a high-yield savings account that you use only for taxes while you earn over 4% APY on it!

Conclusion: keep learning about taxes and speaking the language of money!

If you are a 1099 contractor, make sure you are preparing for your annual contribution to Uncle Sam and lower it by:

  • Calculating your miles
  • Depreciating your equipment
  • Deducting self-employment tax

Disclaimer: This is not financial advice. Information is believed to be accurate but consulting with a professional and/or irs.gov for tax guidance is recommended.

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