Many Americans have recently found themselves joining the gig economy as either a self-employed individual, a freelancer, or a similar short-term worker. If you fall into one of these categories, you are likely wondering how self-employment tax is handled compared with what you've done before. Here, we'll help you feel confident in your understanding of taxes when you're self-employed.
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What is the gig economy?
A gig economy is a job market where many workers hold short-term jobs or contracts, typically working for different companies or individuals rather than longer-term, permanent jobs with one company. There are many reasons why workers might start working a "gig," but common reasons include the desire to earn more money with a side job, to be their own boss, or the loss of a more permanent job.
Gig jobs span a wide range of skills and wage ranges. If you're a gig economy worker, you may have one of the following jobs:
- Consultant
- Handyperson
- Freelancer
- Delivery driver or rideshare
- Airbnb owner
- Tutor
- Photographer
- Fitness trainer
- Online seller
How does working for myself affect my taxes?
If you don't work for a traditional employer, you'll need to track your income and document your expenses to determine your tax bill. If you haven't incorporated or formed a partnership, then your income will be filed through Form 1040. However, you'll also need to complete and attach a Schedule C to your Form 1040 to report your business income and expenses.
If one of your clients paid you more than $600 during the year, then that client should issue you a 1099-NEC or 1099-MISC. However, even if you don't receive a 1099 from a client, or didn't earn at least $600 on a certain job, you still have to report all of the income that you made. For this reason, it's very important to have a system in place to track your income and expenses throughout the year.
What is self-employment tax?
Individuals working in the gig economy will still pay traditional income taxes. However, if you make over $400 per year from your work as a self-employed worker, then you also need to pay self-employment tax. This tax includes Social Security and Medicare tax and is calculated on Schedule SE and filed with your Form 1040. This amount is also reported on Schedule 2, Line 4 of your Form 1040.
The good news is that you can deduct half of the amount you pay in self-employment tax from your income on your Form 1040. For example, $2,000 in self-employment tax reduces your taxable income by $1,000. In the 22% tax bracket, that would mean an income tax savings of $220.
What are quarterly estimated taxes?
Self-employed individuals who expect to owe at least $1,000 need to pay estimated tax throughout the year. Individuals use the estimated tax worksheet from Form 1040-ES to estimate their quarterly taxes. The 1040-ES tax form packet has 4 separate 1040-ES payment vouchers that you can use to mail in your quarterly estimated payments. Even if you are due a refund when you file your income tax return, you may still be charged a penalty if you didn't pay enough in quarterly taxes by each of the due dates for that year.
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What tax deductions are available for the self-employed?
In addition to the deduction for self-employment tax, your new job may also allow you an opportunity to claim more tax deductions than you ever could before. Some common ones are:
- Home Office Deduction: If you have a workspace in your home that you use "regularly and exclusively" for your business, then you can deduct a home office expense. This applies whether you own or rent your home. You have two options for this calculation.
- In the simple method, you can elect to deduct $5 per square foot, with a maximum of 300 square feet, or $1,500 deduction.
- The more detailed method requires that you keep accurate records of your mortgage interest, utility bills, homeowner's insurance, home repairs, and similar expenses. In this method, the percentage of your home's square footage that is used for your home office is then used to determine your deduction.
- Mileage Deduction: The miles you drive to conduct business are also tax-deductible. To get this deduction, you need to keep records of the date, mileage, and purpose of your business trips. Just like the home office deduction, there are also two ways to determine your mileage deduction.
- The easier way is to use the IRS-determined standard mileage rate.
- Or, you can calculate your actual expenses based on the cost of operating your car (gas, oil changes, car insurance, and so forth).
- Education Deduction: When you take classes to maintain or improve your skills directly related to your business, you can deduct those expenses.
Other deductions you may be able to claim include:
- Internet and phone bill
- Health insurance premiums
- Retirement plan contributions
- Business travel and meal expenses
- Business loan or credit card interest
- Publications and subscriptions
- Rent
- Business insurance
- Startup costs
- Advertising
- Contract labor
- Materials and supplies
- Office expenses
- Licenses
How do I pay taxes if I work in multiple states?
Income taxation depends on the physical location of where the work is being done. What this means for the self-employed is that you will pay income taxes to the state where you live and work regardless of whether you provided work for a client who resides elsewhere. You may have to file income tax returns in multiple states if you moved to another state during the year or commute to another state for work.
The bottom line
Working for yourself can be exciting and empowering. When it comes to preparing your taxes, keep these items in mind:
- You should maintain accurate records of all income and expenditures.
- You should complete Schedule C to report profits and losses from your business.
- You should complete Schedule SE and Schedule 2 to calculate and report your self-employment tax.
- You might need to pay quarterly estimated taxes using Form 1040-ES.
- You should take the time to look through the tax deductions available to those in the gig economy.
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