Did you know that you can skip your tax season panic attack and learn how to avoid paying taxes on your 1099s?
Everyone wants to save money on their tax bill. To legally to reduce your amount of taxable 1099 income, you need to know the difference between tax evasion vs tax avoidance.
Tax evasion: Illegally concealing income or information from the IRS. This can result in penalties, fines, or even jail time for the worst offenders.
Tax avoidance: Legally reducing your amount of taxable income or amount of tax owed. Legal methods you can use to avoid paying taxes include things such as tax-advantaged accounts (401(k)s and IRAs), as well as claiming 1099 deductions and tax credits.
Being a freelancer or an independent contractor comes with various 1099 benefits, such as the freedom to set your own hours and be your own boss. However, it can become a serious pain during tax season. That is if you don’t know what you’re doing.
I understand if the mere thought of calculating and paying your self-employment taxes immediately brings you anxiety. Let’s be honest. The only reason you’re jealous of salaried employees is because of the straightforward, quick, and easy W-2 tax forms they get each year.
But remember, you’re in the same boat as around approximately 10.6 million other workers in the U.S. just like you. Keep reading to learn the many ways you can minimize your tax payment as a self-employed individual.
Note: If you want the best way to avoid paying 1099 taxes, try Bonsai Tax for 14 days now. Our automatic tax receipt tracker organizes your deductions, keeps detailed records, and helps you stay on top of deadlines.
You’re probably already familiar with the dreaded 1099 form. The common one that freelancers and independent contractors are used to getting from clients is the 1099-MISC form.
In 2020 the IRS changed the 1099-MISC to cover “other” and added the 1099-NEC form to report the income that you receive from clients. The Form 1099-NEC did not replace the Form 1099-MISC, it only took over the non-employee compensation portion.
There are some other common types of forms that are used to report other sources of income. Interest gets reported on Form 1099-INT, dividends on 1099-DIV, government payments such as unemployment compensation on 1099-G, and other miscellaneous sources of income go on a number of other forms (1099-R, 1099-C, etc.).
If a company or client makes over $600 in payments to an independent contractor, they are obligated to send you a 1099 before January 31st (it was Feb. 1st in 2021 due to Jan. 1 falling on a weekend). And even if someone messes up and you don’t get a 1099 form sent to you, you still required to report that income.
You must report income on your tax return if it is less than $600, but the payer is not required to send you an IRS Form 1099-MISC or 1099-NEC.
If you are self-employed or a small business owner, you understand first-hand how awful your tax bill can be, especially with the giant 15.3% self-employment tax added on (12.4% for social security on the first $142,800 of earned income in 2021 and 2.9% for Medicare).
When you’re not an employee, you don’t have any Social Security and Medicare taxes withheld from your income.
And since there’s no state and federal income taxes, health insurance, or social security and medicare taxes, are taken out of your paycheck, you are the one who is solely responsible to pay self-employment tax. Most individuals working a full-time job would expect a tax refund, but you'll need to pay taxes on 1099 income.
Thankfully, there are plenty of things you can do to avoid outrageous quarterly tax payments and yearly tax payments.
Here are a few ways you can keep some extra money in your pocket when you receive a 1099.
W-2 employees have it easy when it comes to tracking their yearly income. Their employer does that on their behalf. On the other hand, independent contractors need to record your business income or earnings in as much detail as possible so you can easily calculate your net income and determine your taxes.
The more you track and the more organized you are, the better you’ll be during tax season. Remember, you are responsible for paying "both sides" of the self-employment tax. When you know your expenses and accurately track them, you will understand what tax deductions you can get and can maximize them.
Note: It’s critical to separate business expenses from personal ones, as you don’t want to merge the two accidentally. If you want to do all of that automatically, try Bonsai's freelancer 1099 expense tracking software. Our tax software can help you organize all of your expenses and save you money on your tax bill at the push of a button.
Many self-employed people have LLCs, but some wonder if they should make the S-election so their LLC is treated as an S-corp. It depends on your situation. If you’re making over $100,000 each year, have a tax professional help you identify if there’s any benefit to forming an S-corporation.
"Few of us ever test our powers of deduction, except when filling out an income tax form.''
- Laurence J. Peter, author
Fortunately, when you’re self-employed, you’re qualified to write off a variety of business expenses to lower your tax burden. Taking as many tax deductions as possible can help lighten your load. But what exactly can you deduct?
There are many costs that 1099 workers can deduct from their self-employment income taxes, from educational training and office supplies to advertising and travel.
Take a look at the following common deductions for self-employed folks and those who own their own small businesses.
You can claim a deduction on your gas and vehicle expenses from your taxes if you use your vehicle for work purposes. Regular W-2 employees are unable to deduct their commute from their taxes, no one can deduct their commutes.
This can be done in two different ways: the standard milage rate or actual expenses.
In the standard rate method, you will first need to figure out how many miles you’ve driven for business purposes (and personal purposes, if it's a mixed-use vehicle) throughout the year. Then, multiply that number by the standard mileage rate given by the Internal Revenue Service (remember that this changes each year). This is how you claim mileage for taxes to lower your tax liability.
Example: You drove 10,000 miles in a year for business. The 2021 standard mileage rate is 56 cents per mile. The equation would be: 10,000 miles x .56 (standard mileage rate) = $5600 total tax deduction.
You can also choose to write off your actual business vehicle expenses. Rather than using the IRS standard mileage rate, you will record all the expenses you had throughout the year.
If you had a pricey vehicle repair and know your actual expenses will be high, you may want to opt for the actual expenses method, as you’ll receive a larger tax break.
These types of expenses usually consist of:
Example: You drove 5,000 miles in a year for business but drove a total of 25,000 miles. Divide 5,000 by 25,000 to get the percentage you drove for business (20%).
Let’s say your vehicle expenses were $6,000. Multiply this number by your percentage of 20%, and you’ll get the amount you can deduct. In this case, you would be able to deduct $1,200.
Sadly, as an independent employee, you won’t receive a comprehensive benefits package like you would if you worked a W-2 job. But before you start freaking out, know that you’ll still get some perks that can make up for it.
Self-employed workers can deduct their health insurance expenses, including medical, dental, and long-term care. This lowers your adjusted gross income (AGI), leading to less money you have to pay.
However, you can only do this if:
Everyone does business online or by phone these days, making for a perfect tax deduction for those who are self-employed.
All you’ll have to do is determine what percentage of time you use your phone and internet for business purposes. Then, figure out how much you’re paying for that amount of time. This number is your internet and cell phone deduction.
Example: You log 2,000 hours of computer use in a year. 500 of these hours were used for your business. This means ¼ of your internet expenses are deductible.
If you spend $50 each month on internet service ($600 per year), you can take $600 and multiply it by .25. After calculating, you’ll discover that you can write off $150 of your internet expenses for the year.
Self-employed people often work remotely at home or rent out an office space for themselves. If you rent space, you can deduct your monthly rent payment and any equipment you rent.
If you work out of a home office, you can potentially write it off. However, this is a bit more complicated and involves a few requirements. But it can be done.
The standard method and the simplified method both require exclusive business use. In the standard method, you’ll need to determine your home office expenses, making sure to track everything in great detail.
With the simplified option, office space shouldn't exceed 300 square feet. You’ll need to multiply the square footage of your home office space by the IRS rate. The IRS uses $5 per square foot to calculate your deduction.
Chances are (depending on your business), you’ll want to start advertising your products or services to the world. After all, how is anyone supposed to know how awesome you are if they don’t know who you are or what you offer?
Maybe you paid for a seasonal Facebook ad campaign or created an online course to further promote your expertise. First off, congratulations on successfully marketing your company! We’re happy to inform you that you can write these things off as a business expense on your taxes.
As with all business expenses, make sure to keep track of the amounts you paid, what you paid for, and when you paid. This will help you stay organized and will eliminate stress during tax time.
Completing your yearly taxes can be frustrating and a little scary, but it doesn’t have to be. If you take the time to examine your possible deductions, keep track of your expenses (you can easily do it with our tax document organizer) and business income in detail, and remember to take a deep breath, you’ll be just fine.
If you don’t trust yourself, the best thing to do is to ask the experts and turn to a tax-focused program for assistance with your taxes. With professional help, you’ll improve your chances of lowering what you owe and avoiding an audit by the IRS during tax time.
Are you ready to stop stressing about your freelance or independent contractor finances? With its seamless, integrated, and automated tax software, Bonsai could be the solution you’ve been searching for. From expense tracking and income reporting to estimated tax planning and much more, taxes will be a breeze!
Start using our accounting software for freelancers for free today and enjoy peace of mind when tax season rolls around.
Business expenses are ordinary and necessary costs obtained through business practices, whether you’re a small mom-and-pop shop or a giant corporation. If you paid for something that helps your business make a profit, that’s a business expense and may be tax-deductible (with certain specific exceptions such as clothing for work and additional Medicare taxes).
Estimated taxes are quarterly payments that cover your income tax, self-employment tax, and alternative minimum tax. Self-employed individuals, sole proprietors, partners, and S-corporation business owners pay these each quarter to prevent being charged a penalty by the IRS.
Non-self-employed individuals may also pay estimates if they've under-withheld or have significant other income.
You must pay estimated taxes if:
Determine your net income (gross income minus your expenses). You owe self-employment taxes if you earn a net profit of $400 or more. For up to $142,800 of earned income in 2021 the self-employment tax rate is 15.3%. You can calculate your self-employment tax using Schedule SE on IRS Form 1040. Follow Form 1040 instructions to calculate what you owe after the tax year.
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?