What about Contractors?
By: Ernie Neve
In the last month, we’ve had a lot of new inquiries from contractors and “gig” economy workers. We’ve seen this growing from the success of companies like Uber and UpWork, but time and again, by the time these folks reach out to us, they’ve got a tax problem.
It’s especially prevalent with those who work a traditional W2 job in addition to running a side hustle … that side hustle money is taxable.
Frankly, a lot of these people, who are technically contractors, never see their first tax bill coming.
In reality, few things in the world of small business are as misunderstood as the simple status of being a contractor. Large corporations try to limit their liability (sometimes illegally) by claiming that employees are actually contractors. The contractors clients, in the case of a freelancer, might take months to pay invoices, and at the end of the year, you wait patiently by the mailbox for your clients to issue you a Form 1099 … which they never seem to do.
Despite the challenges, the simple fact is that business entities and individuals can only receive income in two ways – either as W2 employees or as 1099 contractors, so the importance of processes for your contracting business cashflow can’t be overstated.
To put it bluntly, if you wait for your clients to send you a 1099 in February, you are in trouble and you can quickly find yourself owing the IRS fines and penalties.
It might seem odd to think that you gig driving Uber on weekend nights might require you to file quarterly taxes, but the truth is … it might not be a bad idea.
Let’s set some expectations really quickly…
The first step of knowing you’ll have a tax problem is just that – knowing you’ll have a tax problem. If you’ve traditionally been a W2 employee, it might be easy to handle some tax software and file for yourself. When you get into multiple streams of income – such as contracting (1099) – you might find it smarter to sit down with us to establish a baseline of expectations on your tax liabilities.
Perhaps the easiest thing to do would be to create a single-member LLC to receive your payments as a contractor. This also gives you some tax benefits, as we’ll see.
This then has a direct effect on where the money comes from, how it is calculated, and any additional taxes you’ll be responsible for – personally or professionally. The biggest concern and most pressing need, then, as a contractor, isn’t “how” to pay your quarterly taxes – or even “when” – it’s understanding how to calculate them and ultimately, that makes it an accounting issue.
Now, as a general rule, 1099 contractors have 2 choices when it comes to calculating quarterly taxes: they can use the data from the previous year or they can track data from the current year with real-time projections. Both schools of thought have their adherents and detractors, but as small business owners ourselves, we’d like to say this…
Why would you only want to be as good as you were last year?
Last year, with the pandemic and so many things “unknown” might be a terrible baseline, and let’s face facts – your contracting work might not have that data to go off of.
Certainly using the previous year’s data can keep more money in your pocket during the fiscal year and then you would merely pay any difference when the annual taxes are filed, but what is the result if you really nail sales this year?
Yep – a tax problem. Of course, the good news is this, by understanding where your business is every day versus the same day last year, you can easily project what that impact will be on your quarterly taxes. Remember, too, that if those estimated taxes are less than $1,000, you won’t necessarily have to pay each quarter.
Professionally, we like to work with real-time data. As a tax professional, I want to know what expenses and potential write offs and deductions you have available to you and use that to project that information into your estimated taxes.
At the bare minimum, we suggest that any 1099 contractor diligently track and collect earnings (in the form of paystubs, or invoices) AND the costs of doing business; in other words, tracking expenses.
Common expenses include anything that is “ordinary and necessary for your business” such as:
· Office expenses
· Meals with clients
· Business software
For you, personally? It is important to understand what your liabilities will be each quarter, too. Remember, as the contractor, you’ll still have an individual return to file in addition to the return for your LLC returns. Here’s something to remember, and I’ve preached about it in these pages many times:
Solid financial reporting solves most – if not all – tax challenges. Sure, we all know people who simply stuff receipts into a shoebox and try to sort it all out at the end of the year, but retaining a tax professional and even a bookkeeper is a great (and surprisingly cost-efficient) way to mitigate how much time and effort you have to personally spend managing your taxes.
The team and I are here for you and a huge part of our goal is to keep more money in your pocket. If you are taking part in the many different contracting jobs available today – even, technically, AirBnB, then understanding your tax liabilities is critical.
Take some time to come in and let’s gameplan how to mitigate any tax liabilities your success as a contractor have created.