Some common occupations that receive a 1099-Misc form, as opposed to the standard W2 at the end of the year, are sub contractors, real estate brokers and insurance agents. Those who have their income reported on a 1099-Misc are considered independent contractors or self-employed by the IRS, and are responsible for paying their own taxes—to put it simply, none of their taxes are withheld during the year.
This can be a double edged sword for many independent contractors in this country—for those with adequate tax knowledge, or access to a qualified tax professional, receiving a 1099 can actually be a good thing. For those who are new to an occupation that reports income via the 1099, or believe they are pseudo tax expert by being able to enter their W2’s in to Turbo Tax—receiving a 1099-Misc can be a disaster at tax time.
In most circumstances, an employee’s (someone who gets a W2 by January 31) net wages, have already had taxes withheld for federal, FICA, and state. They are not totally responsible for their own taxes, but an independent contractor is. The first thing you have to do as one is make sure that you pay your taxes quarterly. The total amount you have to pay is the smaller of these two numbers—either 100 percent of last year’s tax liability, or 90% of the current year’s tax liability. Failure to pay in enough throughout the tax year will result in an estimated tax penalty on your tax return.
The second and most crucial part of being an independent contractor is tracking your business expenses during the year. Taxpayers who receive 1099’s are allowed to deduct their expenses from business activities just like a business owner can, in fact, most small business owners and independent contractors use the same form to report their income, a Schedule C.
The most important expense for independent contractors to keep track of is their auto expenses—namely business miles driven if using the standard mileage calculation. The IRS allows taxpayers to deduct 50 cents for every business mile driven during 2010, the standard mileage rate cannot be taken in addition to actual vehicle expenses like gas, repairs, depreciation, and insurance. Independent contractors must decide whether or not they want to use actual expenses, or the standard mileage rate.
Something else that an independent contractor must take in to consideration in regards to mileage is the definition of business miles—not all miles driven are considered business miles. Miles driven from home to your office are considered commuting miles, not business miles. Miles driven from the office to your worksite or appointment are considered business miles—and obviously miles that your drive while not at work are considered personal miles and cannot be deducted. For those who decide to use the actual expenses method, your deduction can be figured by totaling up your auto expenses and multiplying that number by the ratio of business miles driven. For example, if you drove 30,000 miles for the year, and half of them were business miles, then you could take half of your auto expense for the year as a deduction.
Other expenses in addition to auto expenses that need to be recorded and can be deducted include:
- Advertising expenses
- Office supplies,
- Cost of uniforms/Equipment
- Interest paid
- Legal/professional services
- Meals and Entertainment Expenses
- Lodging expenses
One last topic that independent contractors need to consider is the home office deduction. If you use a portion of your home exclusively for business purposes, you can take the deduction. This will enable you to not only deduct a portion of your living expenses, including rent/interest, insurance, taxes and utilities, but the home office deduction will allow you to turn some of your commuting miles in to business miles.
You can include commuting miles as business miles if you are a small business owner or self-employed person, and you have two offices or work locations: one outside the home and one inside the home. You will need to fill out form 8832 in addition to a schedule C to correctly file the home office deduction.
The best way for small business owners and independent contractors to save money at tax time is to understand what they are allowed to deduct, and also have an expense tracking system during the year that does not include stuffing receipts in to a shoe box—using an excel spreadsheet or QuickBooks is a better option.