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Taxes on consulting fees explained: 6 must-know facts
8
Min Read
Now that you already know how to get into consulting, it's time to find out how taxes work for consultants.
In the U.S. alone, there are more than 42 million self-employed individuals. For many of those, dealing with taxes on consulting fees is a headache -- one that confuses and frustrates even the most number-savvy people, on par with the difficulty presented to some by contract templates or statement of work templates.
However, independent consultant or self employment taxes aren’t optional. While it can be tricky territory, learning how to calculate and pay self-employment taxes for your consulting work is a small price to pay to have the freedom of being your own boss.
In the growing gig economy, platforms like Bonsai are an excellent resource to help you manage your freelance consultant career.
In this article, we’ll explore taxes on consulting fees in more detail, giving you the insights you need to prepare for tax season.
Note: Try Bonsai tax to make your freelance consultant taxes a breeze. Our software will help you identify your tax deductions, estimate quarterly taxes, and stay on top of the filing deadlines. Users on average save $5,600 off of their tax bill. Don't leave money on the table. Claim your 14 day free trial here.
What is an independent consultant?
First and foremost, before you start filing 1099 tax returns, you need to figure out if the IRS actually classes you as a self-employed individual.
If another business tells you what to do and how to do it, you may well be classed as an employee. In that case, the company you work for should take care of all your taxes.
According to IRS regulations, you are generally considered self-employed if “you are a business owner or contractor who provides services to other businesses.”
So, if that sounds like your situation, you need to learn more about taxes on consulting fees.
How are consultants taxed?
If you're working for a company, you're classed as an employee. As such, the company withholds your taxes and pays them for you.
Once you confirm that you are indeed self-employed as an independent contractor or an employee, an obvious question arises:
How are consultants taxed?
The simple answer is that the onus is on you to manage your finances and to ensure you file your tax return. Before you get deterred by that idea, let's consider the significant tax advantages independent consultant have over employees:
- Independent consultant taxes can be offset by deducting business expenses.
- The relatively new TCJA law suspended "unreimbursed employee business expenses", listing them as miscellaneous itemized deductions.
- Independent consultants are eligible to get the 20% qualified business income (QBI) deduction, unlike employees.
- Independent consultants can get individual health insurance plans and retirement plans, whereas employees are on the company’s preferred plans.
Check out our full 1099 consultant tax guide.
Not bad, right?
But that’s not the full picture. Let’s discover more.
Did you know that you can use Bonsai for accounting? Or that Bonsai can help you calculate your 1099 taxes, help you manage them by providing tax estimates, filling date reminders, and identifying your consulting tax write-offs?
Let's see how that works. First, head to your main Bonsai dashboard and have a close look on the left side - we'll be working with the accounting and taxes sections. First click on "Accounting".
Inside the accounting section, you'll see a breakdown of your income and expenses. Both can either be automatically imported from your bank account, or manually added. Work you got paid for via Bonsai will also be registered here.
Make sure this section is properly filled in and click on "Taxes" next.
This is where the magic happens: Bonsai will do all the calculations for you, and we'll provide you with an overview of your tax estimates, a list of tax deductions you can use for the upcoming tax season, and reminders for all the upcoming filling dates.
Simple, right? If you're ready to check out Bonsai and explore all the features, go ahead and sign up for the free trial!
When to pay independent consultant taxes
Self-employed individuals must make quarterly payments to the IRS. These payments are due by the 15th of the month directly after the quarter’s end.
So, in 2021, your quarterly tax payments would be due on these dates:
- January 15th
- April 15th
- July 15th
- September 15th
If you are late, you could potentially pay the estimated tax penalty rate.
Note that even when you make these taxes on consulting fees each quarter, you still need to file your annual tax return by April 15th.
If you think you will owe taxes under $1,000, it’s easier to pay everything together in your tax return. However, if you earn more than this, the IRS will ask you detail the income for each quarter. As such, it’s better in the long-run to make the estimated quarterly payments.
Read on and learn about 6 tips for independent consulting taxes. With the basics in mind, here are a few pointers for managing independent consultant taxes.
Note: If you want automatic reminders sent to you about filing deadlines and an easy way to track your tax deductions, try Bonsai Tax. Claim your 14 day free trial here and see how much money you save. In fact, the average user saves approximately $5,600 from their tax bill.
1. File your tax return no matter how much (or little) you earn
Any income you make must be reported on your tax return. If you do consulting work for three or four companies, they will all report your earnings to the IRS. As such, you need to do your part. Also, if you lose your 1099 form, you'll still need to report your taxes.
If you earn less than $400, you won't owe the IRS any tax. That being said, you should still file a return for the tax year, to stay on the safe side!
Remember: if you don't file a return, you can't claim any tax refunds.
Are you overwhelmed or confused by managing your business finances or preparing for tax season? Join Bonsai to make your consultancy more fun and let us help with expense tracking, identifying tax deductions, and estimating your quarterly taxes.
2. Understand what self-employment tax covers
Currently, the self-employment tax rate in the U.S. is 15.3% of your net earnings. This tax comprises:
- 12.4% for Social Security
- 2.9% for Medicare
Employees and employers share social security and Medicare taxes, splitting it 50/50, with the employer taking responsibility to ensure it is paid.
If you’re self-employed -- and above the $400 threshold -- the IRS will expect you to pay your own independent consultant taxes, which will cover your social security tax and Medicare.
3. Get smart about how you record all your self-employed business income
For newcomers to self-employment, discerning your income is not always obvious. Independent consultants could generate income in multiple ways:
- Sales revenue when customers pay for your products or services
- Bonuses or commissions from referrals or sponsored sales
- Cash gifts from your clients for hitting targets
Knowing how to bill a client correctly is crucial, as that will help you track your sales revenue with greater accuracy.
Moreover, if you use the best tax and accounting software for self-employed consultants, you'll be in a better position to manage other income, such as gifts and bonuses.
4. Know which expenses are tax deductions
Once you become self-employed, you should get into the habit of tracking your freelance expenses, as these can be listed as business deductions to reduce your taxable income (you can track these deductions by using a business expense spreadsheet).
Some common expenses you can list as deductible include:
- Advertising and marketing – Business cards, website hosting, social media ads.
- Home office – Laptops, printers, even a portion of the electric and internet bills may be deductible.
- Vehicle expenses – Travel costs between clients. You can even keep track of mileage for taxes.
- Startup costs – Training programs, starter kits, etc.
- Sample inventory – Demo products can be deducted unless you sell them. In this case, they would be inventory.
With all items that you intend to list as business expenses, you should keep the receipts for taxes to prove the purchase cost.
If you are a legal consultant, check out our list of common tax deductions for attorneys.
Independent consultants don’t need to waste their time when tax season comes. Let Bonsai help you save on taxes and get peace of mind - sign up for your free trial today.
5. Separate your business activities from hobbies
It's quite common for people to become an independent consultant to get a decent discount on a product they like. Much to their surprise, that can lead to a profitable side-hustle, which can soon turn into a full-time business.
As mentioned before, you need to report any income to the IRS, so it's essential that you determine the profitability of your consultant work -- or any other side gig for that matter. Here's our breakdown of a hobby versus business.
6. Be aware of travel
Visor report that consultants who travel a lot may need to file taxes in multiple states. This could come as a shock to some consultants to find out that each state government can claim some of their income if it was earned in that state.
Make sure you don't pay double state tax in this instance, as you may be entitled to a tax credit in your home state if you pay taxes in other states.
Taxes on consulting fees don’t have to be hard
Naturally, it takes a little time to get acquainted with managing your own taxes and filing returns. With these tips, you can be prepared for tax season ahead of time, keeping up-to-date with quarterly payments, expense tracking, your income, and submitting your return on time (to avoid any filing penalties).
If you need some extra assistance in managing your self-employed business and finances, join Bonsai to use the range of specialist tools that make business management much easier for independent consultants and freelance business owners.
What Defines a Verbal Contract?
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.
When is a Verbal Agreement Legally Binding?
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:
- Offer and acceptance: An offer is made and accepted by another party involved in the agreement;
- Consideration: The involved parties must exchange something of value (money, a service, time, etc), this is known as consideration;
- Intention and certainty: All parties must fully understand the terms of the contract and intend to make a legally binding agreement freely; and
- Capacity: The parties must have the capacity to legally enter into the contract; they're above age and of a stable mindset.
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.
How strong is a verbal agreement 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.
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get started nowWhen are verbal agreements not enforceable?
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:
- The sale of real estate or vehicles
- Real estate leases lasting longer than one year.
- Property transfer following the death of the owner.
- The case of a party agreeing to pay debt for someone else.
- Any contract that requires more than a year to fulfil.
- A contract involving and exceeding a specified amount of money (which varies by state).
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.
How are Verbal Contracts Enforced?
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?
How can you prove an oral contract?
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.
Written vs Verbal Contracts: What's the Verdict?
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.
Say hello to digital contracts
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.
Benefits of written contracts
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.
Create Professional Contracts with Bonsai
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?
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