According to the latest Gig Economy Index from PYMNTS.com, nearly a third of workers in the U.S. participate in the gig economy in some way, ranging from driving for a ride-sharing app to providing specialized consulting services.
People participate in gig work because they enjoy the flexibility, work-life balance, and opportunity to earn extra income without a long-term commitment. But gig work also comes with challenges – one of those being taxes.
Directly above view of concentrated accountant using calculator while preparing tax forms sitting on … [+]
Many gig workers are surprised to discover that when they participate in the gig economy, they become small business owners in the eyes of the IRS. What might start as a way to earn a little extra money on the side of a full-time job gets complicated when you have to start thinking about quarterly estimated tax payments, accounting for income and expenses and filing extra forms and schedules at tax time.
To help out new gig workers (or even long-term ones who still struggle with taxes), I collected a few tax dos and don’ts from tax experts and gig workers who learned about taxes the hard way. Here’s what they had to say.
Do make quarterly estimated payments
Federal income taxes in the U.S. are a “pay as you go” system. When you work for an employer, federal and state income taxes and payroll taxes are withheld from your paycheck. When you work for yourself, it’s your responsibility to estimate your tax liability and send estimated payments to the IRS each quarter on April 15th, June 15th, September 15th, and January 15th of the following year.
Beth Logan, an Enrolled Agent and founder of Kozlog Tax Advisers, says lots of gig workers fail to pay estimated taxes and end up owing a lot of money at tax time. “This would be okay if the had the money,” Logan says, “but most are part of the gig economy because they do not have much money or they’ve fallen on hard times.”
Logan says a good rule of thumb is to send in around 20% to 25% of profits to the IRS and 5% to your state, although your actual tax rate will vary depending on how much you make and where you live.
Don’t forget about self-employment taxes
Most people are aware they have to pay income taxes on the money they earn – whether from a full-time job or a side job. But new gig workers are often surprised by self-employment tax.
Self-employment taxes cover Social Security and Medicare taxes for self-employed individuals – similar to the FICA taxes that are withheld from an employee’s paycheck.
“Gig workers need to know that not only will their net profit be subject to income taxes, but they will also need to pay the self-employment tax of 15.3%,” says Bret Scholl, CPA with Scholl & Company, LLP. “Our firm has found that the self-employment tax is a very common surprise for new gig workers.”
Do separate your personal and business finances
Keeping your business and personal finances separate provides an array of benefits. It makes your business look more legitimate to clients and lenders and makes it easier to track business expenses.
Tana Williams, a personal finance blogger at Debt Free Forties who’s been freelancing for over 20 years, says one of her biggest mistakes when she started out was using her emergency fund account for tax savings.
“When I started freelancing, I would throw 30% of my income into a savings account for my taxes. Brilliant right? Unfortunately, that savings account also housed my emergency fund and general savings. Every time I needed a little extra cash here and there, I’d grab it from that account,” Williams says. “By not keeping my cash for my quarterly payments separately, you can guess how quickly that account got drained.”
Don’t fear the home office deduction
If you use a home office regularly for your gig work, you may be able to take the home office deduction. Using the simplified method, the home office deduction is worth $5 per square foot on up to 300 square feet.
In the past, the home office deduction was rumored to be a “red flag” that could get you audited. But home offices aren’t that unusual anymore.
“The home office isn’t an audit red flag, and you should take it if you qualify,” says Logan Allec, a CPA, personal finance expert, and owner of the personal finance blog Money Done Right.
To qualify, Allec says, “you need a space in your home that you use regularly and exclusively for your gig/freelance work. So no, doing your work from your living room couch that you also use to watch TV doesn’t count.”
Do track your mileage
Deducting the miles you drive for business can be a valuable deduction for some gig workers. This is especially true if you work as a ride-share driver or courier, but even home-based gig workers can rack up miles running errands, meeting with clients, and attending business networking events.
The problem is, many gig workers don’t track their mileage, so they have no way to accurately calculate their deduction at tax time.
Dan Henn, a CPA in Rockledge, Florida, recommends getting in the habit of keeping good mileage records right away. “If you drive for your gig, keep a detailed mileage log, either written or use an app like MileIQ.
Don’t forget to save for retirement
According to a survey from Betterment, around 30% of people who make their main income from gig work set aside no money for retirement regularly.
If you’re part of that group, there’s still time to contribute for the 2019 tax year.
Charles Thomas, a financial advisor and the founder of Intrepid Eagle Finance, says most deductions have to take place before year-end to benefit that year’s tax bill, but retirement account contributions are one exception.
“The IRS allows taxpayers the opportunity to contribute up until the filing deadline for certain retirement accounts that can help offset some of your self-employment income,” Thomas says. “A SEP-IRA is a good starting place as you consider the best type of retirement account to reduce your business income.”
For 2019, you can contribute up to 25% of your net earnings from self-employment, up to a maximum of $56,000.
Do work with a qualified tax professional
If you’re new to self-employment, you may have never worked with a tax professional, either because you thought you couldn’t afford it or your tax situation was simple enough to handle on your own.
But being self-employed brings a whole new level of complexity to your taxes, so you should seriously consider working with a professional.
“In addition to preparing and filing your taxes, tax professionals can provide valuable advice to help you and your business be tax-efficient and lower your tax bill,” says Steve Rossman, a CPA with Drucker & Scaccetti.
Are you new to gig work? What tax lessons would you add to the list?