One of the most dramatic effects of COVID-19 on the U.S. economy is the increase in popularity of “gig” or freelance work. Gig workers include those performing essential jobs, such as delivering groceries to socially-distancing consumers. Others used their specialized skills to develop consulting and other independent businesses. According to the independent talent provider MBO Partners, gig workers contributed $1.2 trillion to the U.S. economy in 2020.
It should come as no surprise then, that gig workers are expected to pay their share of income tax. But calculating income tax as an independent contractor is not always simple.
No free ride
If you are a gig worker, you are typically considered self-employed. Because an employer is not withholding money from your paycheck to cover tax obligations, you are responsible for making your own federal income tax payments. Depending on where you live, you also may have to pay state income tax.
The U.S. tax system is considered “pay as you go.” Self-employed individuals typically pay both federal income tax and self-employment taxes four times during the year: April 15, June 15, September 15 of the current year, and January 15 of the following year.
If you do not pay enough over these four installments to cover the required amount for the year, you may be subject to penalties. For federal income taxes, you can avoid penalties if your estimated tax payments are at least equal to either 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year. If your income is under $150,000 ($75,000 if married filing separately), then you can avoid penalties if your estimated tax is at least 100% of last year’s tax,
You may have been called a “1099 worker” or “independent contractor.” This is because as a self-employed person you will not get a W-2 from an employer. However, you may receive a Form 1099-MISC from any client or customer that paid you at least $600 throughout the year. The client sends the same form to the IRS, so it pays to monitor the 1099s that you receive and verify that the amounts match your records.
Related Read: Independent Contractor vs. Employee: Understanding Worker Designation
Third-party payment systems may report gross amounts paid to you on Form 1099-K. Even if you did not earn enough from a client to receive a 1099, you must still report the income that you received from that client. Most gig workers are taxed on income when it is received, not when you send a request for payment (unless you elected the accrual method of accounting).
Because gig workers are self-employed, their taxes are based on the profits left after they deduct business-related expenses from their revenue. Your expenses may include payment processing fees, investments in office equipment and specific costs required to provide your service, such as advertising.
Also, if you use a portion of your home for work, you may be able to deduct some home-related expenses. Note that this is subject to significant restrictions.
Do not go at it alone
To make accurate deductions, it is essential that gig workers keep excellent records of revenue and expenses. As an employee you may have calculated your own income and prepared your own income tax returns. When joining the gig economy, you should consider working with a professional to help ensure that you pay no more tax than is required.
For more information, contact Thomas Vance at 312.670.7444. Visit orba.com to learn more about our Wealth Management Services.