Contractor taxes: keep more, owe less, stress less

We cleaned up the captions for reading and swapped in a few of our words, like “workshop” for “webinar.” Otherwise, the words are the speakers’ own. Check the ten notes above as you read.

Why taxes feel harder as a contractor

0:00Kieren Reilly: Thank you everyone for joining. My name is Kieren Reilly. I’m a CFP® professional in Baltimore, Maryland, and I’ve been volunteering with Advisers Give Back for, I guess, 4 years now. So, this presentation is going to focus on exactly what Matt said. It’s how to keep more of your money, how to owe less and stress less when it comes to your taxes. Some of you may be recent contractors. Some of you may have been doing this for a while. This is really geared for anyone who is just trying to figure out the basics. The basic steps to take in order to set yourself up for a much easier time come April when you’re doing your taxes. So, let’s dive in.

0:58Why does this feel hard? It’s because, as a contractor, the tax burden really falls on you. You’re your own business entity, technically. When you’re paid by an employer on a W-2, your employer handles all of your tax withholding for federal, state taxes, Medicare taxes, all that stuff. But when you’re paid as a contractor, typically on a 1099, none of that is withheld. So, the burden falls on you, and it’s easy to forget that you have to pay these taxes. If you just lay some simple rules down, you’ll be able to set yourself up so that you don’t have a nasty surprise and a big tax bill later. So we’re going to teach you about the systems that you can put in place. Very easy things to do, so that you’re prepared to pay your taxes when the time comes.

2:03As I said, W-2, which maybe some of you are used to, everything’s handled for you. 1099, nothing is, really, and you have to pay not just income taxes, but self-employment taxes, which are Medicare and Social Security taxes. One of the main rubs for contractors is that as a self-employed person, you have to pay all of that Medicare and Social Security tax. Where W-2 people, you’re normally splitting it with your employer. They pay half, you pay half. You’re self-employed here, so you actually have to pay the whole thing. So, what is it that you will actually owe? It’s really your revenue. All the money that you’ve brought in from your employment, minus your expenses, equals your profit.

3:00So that’s what you’re taxed on. And that’s what your taxes are based on. Income taxes, whether that’s federal and state. And then, of course, self-employment taxes, which are, again, based on your net earnings, not your gross earnings. So what are these things I’m saying? Revenue, that’s the money that you’re actually paid. Every dollar that comes in is compensation to you. Business expenses are really what it costs to do the work that you do. If you’re an Uber driver, that’s driving your car, that’s maintenance on your car. If you’re just commuting to work regularly at a job at a school system or something like that, those commuting expenses, they’re business expenses, getting you to your job. So all of those expenses added up, and we’re going to talk about what those typically are, minus your revenue is your net profit. Really, what’s left over, all the gross that you’ve come in, minus the expenses equals your profit.

4:07And that’s what these estimated taxes are going to be based on.

The set-aside rule

4:11Kieren Reilly: What’s an easy rule to follow? It’s a set-aside rule. It’s really a monthly habit of putting aside a certain percentage of your income every single month into a separate account. A whole different account, probably just a separate checking account that is earmarked for taxes. Taxes only. That’s a great way to just immediately take some of your income, a percentage, maybe 25, 30% of your income. Park it somewhere else so that you know, hey, this is not money I’m spending. This is money that I’m going to owe in taxes at some point. And that way it’s set aside, and you don’t have to pull it out of your checking account that you normally buy groceries with, because it’s somewhere else.

5:11A really simple way is just to have a percentage. For a conservative estimate, it’s probably 25-30% of your income. If you live in a higher tax state, like California or New York, maybe you want to go on the higher side of that. If you’re making a lot of money as a self-employed person, maybe you want to be closer to 35 or even 40% set aside. But as a general rule of thumb, around 25% to 30% is a pretty safe estimate for what you’ll likely end up owing, just as a starting point. As you get further along, and you end up seeing what your tax bills actually look like, and what your percentages actually are, you can fine-tune that number. But start somewhere in that range, is my recommendation.

Quarterly estimated tax payments

6:09Kieren Reilly: When do you have to pay your taxes? You could pay them all at one time in April, but you’d be subject to penalties for underpayment throughout the year. So the best practice is really to file quarterly estimates. That’s in April, June, September, and January. And to just pay along the way. That way, you don’t have a penalty for underpayments, because you’ve paid in as the months have gone by. So I would recommend, as you’re setting up this system, to just set up reminders in your calendar, every quarter, starting in April, to pay your taxes.

7:01And put those quarterly estimates in. Of course, that also means you’re paying along the way. You don’t have as big of a cash crunch later, less of a surprise because you’ve put money in.

What counts as income and expenses

7:14Kieren Reilly: What’s tricky and is going to vary for all of you is really what counts as income. And depending on whether you’re on a platform, like Uber driver or TaskRabbit or something like that, they may send you invoices. Some sort of reports that could track some of these expenses, but they might not tell you everything. So, really, what counts as income? It’s all of the payments that you get, the 1099 income that you receive. Any additional non-1099 payments typically also counts. These platforms sometimes report things differently. You just want to make sure you’re keeping tabs on what’s coming in, so that you can have a rough estimate of what your total income is looking like. Expenses, again, this varies depending on what your business is. Rule of thumb is if it’s an ordinary and a necessary expense for work. If you need to drive to your job site, that’s an expense for work. If you need to buy a laptop to do your job, or pay some software to help you do your job. All of those things that are part of that expense of doing your work, whatever it is, are likely going to be deductible expenses that you will want to keep track of. Because again, your income minus your expenses equals your profit.

8:53And what you have to pay tax on. So if you can really keep track of all of those expenses, you can help reduce what you ultimately owe. By recording all of the deductions that you’re eligible for. So track them. Keep receipts. Keep a separate folder. And be really diligent if this is a business expense, that you’re making a note about it. As I said, some common things here are listed, like vehicles and professional services. Whether you’re using a home office, if you’re eligible to do that. Business cell phones, stuff like that. Again, this varies for businesses, whatever your business is. But anything that’s related to your actual cost of doing your job, it’s likely going to count as a deductible expense.

Keep business and personal money separate

9:51Kieren Reilly: The biggest mistake that I see self-employed people making is mixing business and personal expenses. It’s really a good idea to have a separate account that you have for your business savings. And even a separate credit card, if you’re having a lot of expenses, to be business only. It really creates a very clean accounting of what’s happening for your business only, and is not mixing in personal expenses that could muddle the picture. Or make your life more difficult when it comes to filing your taxes later. So, number one rule of thumb here, or recommendation here, is to have a separate business checking account and a card, if you’re going to have expenses. As a self-employed person, unless you have an LLC or something like that, if you’re just a sole proprietor, you can set up a business checking account. Just with your Social Security number.

11:02If you do have an LLC, you’ll typically need what’s called an employer identification number, an EIN, which is a separate tax number to open that account. But it’s a great idea to just have a separate checking account, separate card. Really makes your records clean. It makes any filing that you have to do, or, God forbid, if you get audited, you’re going to have a much easier time. Figuring out what is a true business expense or income versus what is a personal item that shouldn’t have been where it is.

Ten minutes a week on your records

11:45Kieren Reilly: As with most financial planning recommendations, if you have just some good, basic habits that you get into, they can have a huge impact on making your life a lot easier over time. So, record keeping. If you just devote 10 minutes a week to keeping track of what income has come in, what expenses have gone out. Have I set aside my percentage, my 25% into my separate account for taxes? If it’s coming to quarterly tax time, have I calculated what my estimate should be? And am I mailing that payment or sending that payment in to the Fed and to the state? Really easy to just set a weekly reminder, 10 minutes, at the beginning of the week, or at the end of the week. To just help do that little bit of cleaning while those memories are fresh in your mind about what that expense was. It’s going to be a lot easier than trying to figure out what that expense was 2, 3 months from now, when you may not remember.

12:58You should probably also have a tax folder. Set aside all of your 1099 income documents that you get, track your mileage, your bank statements, your logs, if you use mileage for your work. And it’s just going to make it a lot easier. If you’re going to either do it yourself with TurboTax, or if you’re going to have a tax preparer help you file your taxes, having clean records is going to make everybody’s life a lot easier. If you’re doing it yourself, it’s going to make your life a heck of a lot easier. And if you’re using somebody, they’re going to have to almost be pulling teeth to get all these records from you if you don’t have it. So, what are some red flags to avoid? If you have just an enormous deduction that you’re claiming with no documentation on what that expense actually was, that could be a problem. So, if you are having a big expense, make sure you’re keeping good records of what that is.

14:02Again, we said this: mixing personal and business expenses, or trying to fudge things that really aren’t business expenses as business expenses, can get you into hot water. So be careful there. If you’re claiming your vehicle deductions, but you don’t have a mileage log, that can be a problem. And if you’re consistently showing year after year of big losses in your business because of big expenses somehow, and you’re never showing a profit, the government might wonder. How is this person staying afloat? And you could run risk of potentially being audited. So, don’t lie. What are the audit-proof habits? It’s these low-effort, high-impact things.

14:54It’s that 10 minutes that you set aside each week to keep your records clean. It’s keeping digital receipts. If you get a piece of paper handed to you with receipts, just to snap a quick picture of that on your phone. And make sure you have a digital copy in case that piece of paper gets stuck in the wrong pocket and goes to the wash. If you have any big or unusual expenses, put some notes on there so that you remember what this expense was. Again, it’s going to be hard to remember months and months, or even years later, of why that was such an oddball expense. So do yourself a favor and make sure you’re keeping good records there. Track your mileage as it occurs. If you’re doing driving daily, just tally it up at the end of the day. It’ll make your life a lot easier. And then, of course, as you’re sending in your quarterly estimates, you want to make sure you’re saving your receipts.

Year-end checklist and next steps

15:50Kieren Reilly: What do you do at the year end so that April is easy? You want to make sure that your records, your bank records, match what the platform records are that you’re getting from Uber or wherever else. You’ll want to make sure you’re pulling these summary categories, you’re verifying your deductions, and just preparing a clean packet of information for tax filing time. It can be a folder that you’re setting aside. What should you do from here? The 3 easy moves, number one. Well, you could choose 3. I’d rather you do all 5 if they apply to you, but number one is definitely to open a separate tax savings account. And to try to separate this personal and business expenses as quickly as possible, so you have clean records. Number two is definitely to schedule some time, 10 minutes a week, just to make sure that your records are staying clean, and that you’re tracking your expenses.

16:58And then, make sure you’re paying your quarterly estimates. If you decide to use a tax preparer, just make sure that they’re well-versed in whatever it is that your business is. I probably see a lot of self-employed tax returns, but just ask them, what information are you going to need from me? How can I make all of our lives a little bit easier? If you’re going to use TurboTax, which does work for self-employed people, you’ll want to make sure that you’re keeping good records. So that you can make that time a lot less stressful as you’re inputting all of that information. Hopefully, what you’ll get after going through this is some clarity on what you owe and why. You’ll be able to have a controllable, predictable system to set aside money for taxes. So that you don’t have a very nasty, big tax bill that you gotta pay unexpectedly.

18:07Hopefully, you’ll have some confidence that in having a clean record, you’ll have less mistakes, less likelihood of landing yourself in hot water. And hopefully, of course, finding this tax thing much less stressful. So, with that, I’m going to close. As I said, I’ve been a pro bono financial adviser with Advisers Give Back for 4 years. It’s a phenomenal service. If you want to schedule a time to talk about your situation in depth, one-on-one, with the CFP® professional, this is a phenomenal service. And I really encourage you to take advantage of it. It’s free if you qualify. So with that, I’m going to turn it back to you, Matt.

Q&A: LLCs, home offices and mileage logs

18:55Matt Iverson-Comelo, host: Thanks, Kieren, really appreciate it. So one is from an attendee: are contractors the same as having an LLC?

19:21Kieren Reilly: No. A contractor is anyone who is paid independently on a 1099. You can be what’s called a sole proprietor, which is just you operating as your own business, without having an LLC. So, they’re different. An LLC is a limited liability company. It’s like a pass-through entity that people will set up if they’re going to be in business for the foreseeable future. And they want to have a separate entity that they create for, really, liability purposes. That is different, and it’s pretty easy to create an LLC if you wanted to. You’ll just need to go to, most likely, your state that you’re in. You’ll need to get an employer identification number, which can just be obtained from the IRS.gov.

20:28And a name. And they’re pretty easy to create if you wanted to have that LLC, but it’s not necessary. You can just be a sole proprietor and be the business of you.

20:42Matt Iverson-Comelo, host: And just a note: I know we have typically a lot of people joining from California. It is a requirement: you have to pay $800 a year in California if you have an LLC, so there is an expense there. Here’s another question: what would be the deductible expense if you’re working a 9-to-5 job with W-2, and have work-from-home office, and you’re hybrid? So, aside from the internet and cell phone, are there other deductible expenses to think about?

21:16Kieren Reilly: If you’re W-2 only, then you’re probably not going to be able to deduct any expenses. If you have a mix of W-2 and 1099, then you may be able to deduct some home office expenses for that time that you’re the 1099 employee. Other than that, I would recommend that you speak with a tax preparer, honestly, because it really is an individual circumstance question. I’ve seen people deduct their home office. I’ve seen people deduct their internet or their cell phone. But that might be it, if there’s nothing else beyond that that you’re having to spend.

22:08Matt Iverson-Comelo, host: And then there was another follow-up question from the same person. With the mileage for commute driving, would we just keep a chart in Excel, or are there tax forms we’re supposed to complete?

22:22Kieren Reilly: That’s a great question. You should be able to just keep a record in Excel and be fine there as just a good starting point. You can just Google mileage trackers and see if there’s some free tools that are out there, so you don’t have to build it yourself. What I’ve seen is most of the times people will just use that, and they’ll be fine. Their tax preparer will say, oh, okay, well, I feel comfortable putting in this number of mileage, because this seems like it’s in the right ballpark.

Q&A: quarterly payments, phone bills and side income

23:03Matt Iverson-Comelo, host: So the question is: where would I go to submit quarterly estimates? With general W-2s, yearly taxes are due on a set date. Are 1099 filers the same?

23:19Kieren Reilly: That’s a great question. So, you’d have to submit your quarterly estimates with the government, the federal government, and your state government, wherever you may live. And these estimates are due, at least for the federal, and I’m pretty sure the state is the same. It’s April 15th, June 15th, September 15th, and January 15th. That’s the due date. So you can put them in a little earlier if you wanted to. But that’s typically when you need to have them in to have them count for that quarter.

23:58Matt Iverson-Comelo, host: Great. I’m wondering how to separate, for example, the phone internet portion. So, how to separate out expenses, or would you bundle them together, or phone, internet, effectively the same thing? Or is that just a question for your provider? If you call AT&T and try and figure out how much you’re paying in phone, how much in internet? I think that’s the question.

24:25Kieren Reilly: Yeah, I don’t have a good answer there. I mean, if you’re working from home, and you have phone and internet at home.

24:35Matt Iverson-Comelo, host: Oh, sorry, there’s a correction here. So, using it for personal versus professional. So, if you use one line, say, use your internet to stream Netflix, but you also use it for work, to take Zoom meetings, I guess.

24:52Kieren Reilly: Yeah, that’s a good question. It falls into a gray area where I’m not sure. I’m not a CPA, so I would defer to whatever an accountant says there. Sometimes there’s a little bit of wiggle room where an accountant may say, okay. Well, we’re going to just put an estimate that you’re spending 8 hours a day at home doing work. And so a portion, a percentage of your expense for this internet is going to be viewed as a business expense versus personal. But definitely check with an accountant there.

25:30Matt Iverson-Comelo, host: Okay. If I run a small business, side business, with income around $1,000 to $5,000 annually and no 1099, can I still file my taxes?

25:45Kieren Reilly: Yeah, you can file your taxes. You probably won’t owe anything.

25:49Matt Iverson-Comelo, host: It’s good to…

25:52Kieren Reilly: …to file, because who knows? You might be eligible to actually get some benefit back. Or if you have, say, health insurance, you would be able to prove that you’re eligible for subsidies, if you’re on the healthcare exchange. So, I wouldn’t be afraid, if you have really minimal income, to file, because everybody gets a big standard deduction these days. That would almost certainly take your income, taxable income, to zero, and you probably wouldn’t owe anything.

26:28Matt Iverson-Comelo, host: And then, I think this is the same person. If I work as a contractor and use phone for checking in and out, as well as for picking up shifts, would I add my phone plan? And my phone, if I recently bought it as well?

26:41Kieren Reilly: Great question. Again, I don’t want to give tax advice here, so I’d punt that to a tax professional.

Q&A: Roth or traditional IRA, and getting started

26:49Matt Iverson-Comelo, host: Right. What’s the best… I think this is best retirement account, Roth? I think this is a bigger question: what type of retirement account should I have? As a 1099 worker, I guess.

27:02Kieren Reilly: Yeah, it’s a complicated question to unpack. I’ll try to do it very simply. A Roth IRA, it’s a tax-free retirement account. You don’t get a tax deduction when you put money into it. But all of the growth, once it’s in the Roth IRA, it’s tax-free. And when you take money out of it past a certain age, retirement age of 59 and a half, it’s tax-free coming out. So if traditional IRA, the other option is you get a tax deduction. What you put into the traditional IRA reduces your income for that year. But because you took a tax break, you’ll have to pay income tax on the money when it comes back to you later. So it’s a question, boils down to: do I think I’m going to be in higher tax brackets later versus where I am now? Do I need the tax break, or do I not?

28:04For some people, if they’re early in their career, or if they’re not making a lot of money yet, then Roth tends to be a good option. Just to put aside some money in a tax-free account. If you’re later in your career, and you have a higher income, and you’re getting into higher and higher tax brackets, then taking the deduction tends to make sense.

28:27Matt Iverson-Comelo, host: Right. Would a car payment count as expense, or only gas?

28:38Kieren Reilly: Fantastic question. I don’t think your car payment, your loan payment, would count. Again, ask an accountant. I know gas counts. If you’re tracking your mileage, that counts. If you have odd expenses with your car, just run it past an accountant. A lot of these things, if you don’t hire an accountant, sometimes there are some articles that are written online. So you can do a little sleuthing yourself to try to figure that out.

29:15Matt Iverson-Comelo, host: When is the due date to open a retirement account for 2025 and limit money? I think this is contributions.

29:25Kieren Reilly: April 15th.

29:28Matt Iverson-Comelo, host: Great. Next question, we’ve got just a couple more here. I wanted to become a contractor slash freelancer. When should I start setting up the accounts and tracking the expenses? Until I get the first contract, or as soon as I want to pursue projects? Thank you.

29:51Kieren Reilly: Fantastic question, and as early as you can. If you’re going to start spending money on this contracting business before you actually are receiving money, you want to track those expenses. So if it’s something you’re serious about, I would just go ahead and open up that separate account. And that way you have, right from the gate, very clean accounting with anything related to that business.

30:22Matt Iverson-Comelo, host: Two more questions. So, if I only get a small amount of income, I might not even owe anything. Is there a minimum income when you have to pay? I think there’s a follow-on question from an earlier question. It looks like it’s the same person that was asking about the side business earning $1,000 to $5,000 a year.

30:48Kieren Reilly: Yeah. I don’t know if there’s an exact dollar amount that I can give you. I can say, for a single filer, everybody gets a $16,100 standard deduction that they can take. That’s just a deduction off of your federal income. So if you make less than $16,100, at least federally, you won’t have any income tax paid or owed. With the states, not certain, but I think it’s around that number. But you’d have to double-check with whatever state that you’re in.

31:38Matt Iverson-Comelo, host: Great, and then last question here. I’ve reported my taxes as joint with my spouse. Should something change if I report taxes as a contractor? Thank you.

31:49Kieren Reilly: It doesn’t have to, no. As a contractor, if, let’s say, you’re just a sole proprietor, Susie business, whatever it is, then that still flows onto your personal tax return. And onto your joint tax return with your spouse. There would just be some additional tax forms in your return. Probably would be a Schedule C, where all of your business income and expenses and net profit is recorded. So I would encourage anyone here on this call to just look at the form, IRS Schedule C. That’s the main tax form that sole proprietors use. And you can just see what types of business expenses are listed there, how that net income is calculated.

32:48And then, once you do your taxes, or your preparer does your taxes, you’ll be able to look at that form. And see gross income, all of the expenses tallied up, net income. And then see, well, how much did I actually make in profit? What should my set-aside number be for taxes? If I was doing 25%, was I doing too much? Do I need to do more? So that’s a good place to just keep an eye on where the numbers end up coming out for the year.

33:19Matt Iverson-Comelo, host: Wonderful. This has been really illuminating. There’s a lot of good information. I’ve learned a few things that I’m sure I can apply for the work that I do. Oh, there’s one more question. How do these guidelines apply to being a landlord? Do they at all?

33:42Kieren Reilly: Yeah, I mean, being a landlord is really a business. So you will want to have separate accounts for that business income, separate tracking for the business expenses that you have, maintenance that you do on the property. So in many ways, it’s very similar. Tax-wise, sometimes with property, there’s a little bit extra nuance with maybe depreciation of property that you can take that you can’t do as just a regular business owner. But yes, all of those separate personal and business rules of thumb still apply.

34:30Matt Iverson-Comelo, host: Great. It’s 8 o’clock on the East Coast, so we really appreciate you staying up late and at work to take this. So, thanks again, Kieren, really appreciate it. And people are really grateful in the Q&A as well.

34:57Kieren Reilly: Thanks, everybody. Take care.

34:58Matt Iverson-Comelo, host: All right, good night. Thanks again.

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