Business accounting and taxes are a source of much confusion and intimidation for many self-employed workers. Being a self-employed consultant is certainly liberating -- but can also get overwhelming, considering that it requires being a one-person enterprise, responsible for running every aspect of the business.
Between soliciting clients, estimating the scope and cost of each job, and doing the contracted work, staying on top of taxes too can make a freelancer's head spin.
If you are an independent contractor trying to understand how to properly file your 1099 taxes, this article will give you an idea of how it works for self-employed workers -- as well as show you how to significantly reduce the learning curve and the workload that comes with doing one's own accounting by letting the smart Bonsai Tax app do most of the work with minimal maintenance from you.
Note: If you want to make your 1099 consultant taxes much easier and save a lot of money during tax time, try Bonsai Tax. Our app scans your bank/credit card statements to discover deductions as well as remind you of important tax filing deadlines. Users of our software generally save $5,600 on their tax bills. Claim your 14-day free trial here.
When it comes to the Internal Revenue Service (IRS), whenever you see the number 1099 in terms like "1099 worker"/"driver/"consultant"/etc., it is a reference to the series-1099 IRS tax forms that are typically involved in the filing of a tax return for self-employed solo entrepreneurs (to be addressed further in the article).
Let's start with the term "consultant" first.
Throughout the article the terms "independent contractor" and "consultant" are used interchangeably, but it's helpful to understand the technical difference between the two.
"Independent contractor" is a legal umbrella term encompassing the wide variety of professionals within the independent workforce in the U.S. Such individuals are classified as "non-employee"/"non-salary" workers because they don't make a commitment to a singular employer but, instead, enter into non-permanent contracts with multiple clients. The relationship between an independent contractor and their client is non-permanent, and non-monogamous, so to speak.
A client can be a large corporation, a small firm, another freelancer who needs help with some aspect of their business and, of course, anyone from the general public that needs a specific service done.
According to the IRS, a professional is considered an independent contractor "if the payer has the right to control or direct only the result of the work and not what will be done or how it will be done". In other words: you are not an independent contractor if your services are controlled by an employer.
Countless professions across a wide range of industries can be -- and are -- performed on an independent basis, for example:
Being an independent contractor legally classifies one as "self-employed", subject to paying taxes as a "non-employee worker".
Now, the term "consultant" is more of a non-legal classification of the type of independent contractor work: an expert who consults/advises others on a niche topic they are qualified in. Typically, independent consultants help their clients enhance the positive aspects of a given business as well as solve pains and problems holding it back.
Consultants are hired by companies or private clients in need of an external helper to let them sort / fix things in business or life. Among the most sought-out of independent consulting careers are:
As with everything else, there are pros and cons to being an independent contractor -- even in how taxes are handled for self-employed workers vis-à-vis classic "salaried employees".
In the U.S. all income apart from "gifts" is considered taxable income and everyone must pay taxes on what they earn to the IRS on a "pay-as-you-go" basis. But how taxes are paid each tax year depends on what type of taxpayer one is. For example, money earned by W-2 employees is considered a "salary", while money earned by independent contractors is considered "non-employee compensation" -- and this distinction makes a difference in the taxpaying process.
The majority of American workforce is currently comprised of wage and salary workers -- also known as "W-2 employees" (named so for the W-2 IRS form they use to file their tax return).
A W-2 worker has it easier than 1099 non-employee workers in the sense that they don't have to worry about the calculation and the timely payment of their taxes. All they have to do is instruct their employer (by filling out tax form W-4) what percentage of income taxes to withhold from each paycheck -- and this is automatically done throughout the tax year. All a W-2 employee typically has to do taxes-wise is to file their tax return for the tax year in the April of the following year -- and (if they did it right and overpaid a little) wait for their refund.
1099 workers In contrast, don't receive an evenly-split paycheck from a singular employer but, rather, have multiple streams of income from different clients paying different sums for differently-sized projects/contracts in the form of pre-taxed income. As such, independent contractors are responsible for calculating and paying tax estimates on their income -- on a specific quarterly schedule provided by the IRS.
1099 workers also are not eligible to receive the types of employee benefits received by salaried workers (most notably medical/health insurance) because, once again, they work for no one but themselves.
However, there are advantages to being a 1099 self-employed taxpayer too!
One is that, unlike W-2 employees, as a freelance worker, you are allowed to contribute quite a bit of money to your solo 401k retirement plan (contributions are capped at $58,000 for the year 2021).
Another substantial advantage of being on the 1099 taxpaying regime is that you are more in control of your taxes -- and can pay fewer taxes because, unlike W-2 employees, you can write off a bunch of business expenses as consulting tax deductions!
There is your gross income (the raw sums you are paid pre-tax and pre-deductions) and, then, there is your "adjusted gross income" (AGI). AGI is what you get after you adjust your gross income down by mathematically "deducting" the necessary costs incurred throughout the tax year that directly benefitted your business from the total. If you put in the effort, you only pay taxes on the resulting lower sum -- which can add up to thousands of dollars in savings.
Typical business expenses that may qualify for self-employed tax deductions for independent consultants include:
There are just a few examples but the 1099 deductions list gets longer and there are lots of opportunities to write off quite a bit from your AGI. If you pay attention to your spending, hold on to your business expense receipts, and keep clear and updated records of what you spend on which goods and services, you can save quite a bit of money in taxes!!
As a 1099 contractor, you'll also be paid in full for your services. Unlike a salaried employee who has their taxes withheld from their paychecks, a freelancer will be paid without any withholdings. If they received payments in full via PayPal or Venmo, they would have to pay taxes on their earnings later.
Note: Now, if you are looking for the best tool for the job of tracking and sorting your tax receipts -- one that will automate the majority of these tasks and improve the health of your business accounting in general -- try Bonsai Tax! Claim your 14-day free trial today.
Independent contractors, in most cases, are responsible for paying the following two types of taxes.
All taxpayers pay federal income tax. To know the rate at which you are taxed for a given year, you must have an idea of your projected income for that year -- and look up your marginal tax bracket for the specified percentage.
Some U.S. states levy their own state income tax. In some states it's a fixed rate (reset annually), for some it's a graduated rate, and several U.S. states do not collect income taxes at all.
This is rare but, in some U.S. regions, there also exist additional local "county taxes" (put directly toward local community-building efforts).
1099 Consultants also pay the so-called "self-employment" tax, which is, essentially, how freelancers pay Social Security and Medicare taxes. For the year 2021, the self-employment tax rate is set at 15.3% (which breaks down to 12.4% for Social Security; and Medicare at 2.9%) -- and is to be applied to 92.35% of your net earnings.
Check out Bonsai's free 2021 self-employment tax calculator and see estimates of what you owe for the year.
As mentioned, the "pay-as-you-go" U.S. taxation system requires that self-employed workers make estimated tax payments on a quarterly basis -- if they owe $1000 in taxes for that year, that is (if it's less than $1000, they can wait until filing their tax return to settle what they owe for the year).
What this means is that, at the beginning of each tax year, you should reasonably estimate how much income you are expecting to earn, divide that number by four, and set aside 30-35% of your income for each of those quarters to send to the IRS by the specified quarterly deadlines.
The due dates for the 2021 quarterly estimated tax payments are:
Quarterly estimated payments are submitted to the IRS with the 1040-ES form, though the easiest latest way to do so is through the IRS2Go mobile app.
Big bucks or pocket change -- coming in from full-time work or a side hustle: the IRS wants you to pay a percentage in taxes on everything you earn from everything you do. If you under-report, misreport, or altogether fail to report how much money you made each year -- and the IRS catches on -- there will be penalties.
Not only that, they expect you to:
Besides paying quarterly estimates, it is all taxpayers' responsibility to file a tax return by April 15th of the following year. If you miss the deadline, you'll be subject to the 1099 late filing penalty rate.
This is where forms 1099 come into play.
Forms 1099 are "information returns" forms, issued by the payer/client/employer to the independent consultant whose services had been contracted (usually for $600 or more, but sums vary depending on the 1099 form version).
There is a wide selection of 1099s a self-employed worker can be issued. Let us take a quick look at a couple of versions you are most likely to receive as an independent consultant.
Other 1099 tax forms may apply for various types of independent earnings (for example, 1099-INT for interest earned; 1099-DIV for dividends; 1099-G for collecting money, like unemployment, from the government; 1099-R for payouts from a retirement plan; 1099-S for gains from real estate; 1099-MISC for miscellaneous income that does not fit within the parameters of other 1099 forms).
When you are expected to earn $600 or more from a job, it is the client's responsibility to issue you a 1099-NEC -- as well as send a copy of the same form to the IRS. Ideally, a client is supposed to ask you to fill out a W-9 form around the time of the signing of the contract (if they forget to do so, you can volunteer this form to them). You are supposed to receive a 1099 from the client (which will state how much money you earned from this client) right after the tax year ends, so that you can file it with your tax return in April.
The deadline for issuing a 1099-NEC for the year 2021 is February 1, 2022.
The above rule applies exactly the same when you contract a freelance worker to do a job that cost you at least $600. As soon as you know you are hiring an independent contractor for $600+, send them an empty W-9 form and ask them to fill it out ASAP. The W-9 form will give you all the information you need to fill out the 1099-NEC, when the time comes to send it to the contractor and to the IRS.
If your client sends the 1099 form to an outdated address or, perhaps, forgets to issue one at all, you are, on your end, still responsible for reporting that income to the IRS and paying taxes on it (you still need to report cash income).
This should be easy if you are keeping track of your income (best done with a consultant accounting app like Bonsai Tax): the IRS won't hold the lack of a 1099 form from a client against you if you report that income on the Schedule C of form 1040 of your tax return.
After all, you are required to report 1099 income under $600 too -- without any 1099s to show for it. As long as it all was factored into your quarterly payments and is acknowledged on the tax return, you should be in the clear of any penalties with the IRS.
A point worth repeating is that, while you can't avoid paying income taxes altogether, you most certainly can pay fewer taxes, if you write off your business expenses as tax deductions! Our tax software is designed to help independent consultants with this -- and so many other business-accounting-related tasks.
If you only let it, the smart, cloud-based Bonsai software will hit the ground running in taking over the most painful and painstaking parts of sorting, tracking, maintaining, paying, and filing your taxes.
All that's required of you is to answer some questions about your business at the beginning of setting up your account -- and to make sure to document any money that is coming in or going out toward business expenses that are not taken care of by automation.
Just a few things Bonsai Tax can do, as they say, "with its eyes closed and both hands tied behind its back":
Try it for free for 14 days and experience the functionality and the relief of having the right toolkit for your accounting needs.
Entrust your consulting business bookkeeping to Bonsai Tax -- so that you can focus on what truly matters to you: the great work you do for your clients!
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?