Balance Pro Staff
April 21, 2023
It's no secret that taxpayers often wish for a loophole that could magically reduce their tax payments to zero. However, unfortunately, such a secret does not exist. Nonetheless, there are legitimate tricks that freelancers, 1099 independent contractors, and self-employed individuals can use to significantly decrease their tax bills. Interestingly, the IRS has already built provisions into the tax code to account for these situations. This is where tax avoidance comes into play, which is the legal art of minimizing, reducing, and avoiding taxes altogether.
As it stands, most freelancers tend to overpay their taxes, and this is something you should avoid. Therefore, we have put together tricks to ensure you're not one of them. Among these tricks is one that can help reduce your self-employment tax, and five others that can lower your income tax. So, keep reading to find out how to make the most of these provisions and pay only what you legally owe.
Independent contractors do pay more in taxes than regular employees. However, there are ways to minimize your tax bill if you are a 1099 independent contractor. This is precisely what we'll be discussing in this article. Typically, self-employed individuals are taxed at a higher rate compared to those who work for an employer.
The reason why 1099 workers pay more taxes is that, as a W-2 employee, your employer automatically withholds 7.65% of your income from your paycheck for taxes. This amount covers Social Security and Medicare taxes, also known as FICA. Additionally, your employer is also required to pay an additional 7.65% to the IRS.
However, as a 1099 independent contractor, you are your own employer, meaning you are responsible for paying both halves of the bill, totaling 15.3%. This rate is commonly referred to as the self-employment tax, and it's a significant expense for every freelancer.
In summary, because there is no employer to share the tax burden, self-employed individuals have to pay a higher percentage of their income in taxes than traditional W-2 employees.
The self-employment tax only applies to your net profit, not your total gross income. This is because the IRS acknowledges that running a business incurs expenses. As a result, the IRS permits and even encourages the deduction of all business-related expenses before calculating your taxable income.
Your taxable income is essentially the difference between your total gross income and your business expenses. Therefore, by deducting your business expenses, you can lower your taxable income and, in turn, decrease the amount of self-employment tax you'll have to pay.
In most cases, you are required to pay taxes on your 1099 income. If you earn over $400 as a self-employed individual, you must file taxes. While it is possible to minimize the amount of tax you owe on your freelance or small business earnings, it's not possible to avoid paying taxes entirely.
Typically, taxes are only applicable when you earn above the standard deduction amount, which is around $12,000 for single individuals and $25,000 for married couples. However, the threshold for freelancers and contract workers is only $400.
The reason for this lower threshold is that self-employment income is taxed differently than other forms of income. This applies to all self-employment income, whether it's a part-time side gig or a full-time career. Since self-employed individuals are responsible for paying both the employer and employee portion of taxes, the threshold is lower to ensure they are contributing their fair share to the tax system.
When we talk about "1099 income," we are generally referring to self-employment income that independent contractors receive from clients. The 1099 form is used to report this income, but there are two types of 1099 forms: the 1099-MISC and the 1099-NEC.
The 1099-MISC form is commonly used to report miscellaneous income, such as rent payments and legal settlements, and is no longer used for reporting self-employment income from contract work.
Instead, the IRS created the 1099-NEC form, which stands for "Nonemployee Compensation," specifically for reporting income earned by freelancers and 1099 gig workers. However, if you receive payments via electronic platforms such as PayPal, you may receive a 1099-K instead. The differences between these forms are explained in our guide to the 1099-NEC vs. 1099-MISC.
Regardless of the type of income or 1099 form you receive, you are required to report it on your federal tax return. Even if you don't receive a 1099 for your work, you must still report and pay taxes on your self-employment income if you earn more than the $400 threshold.
It's no secret that writing off business expenses is the most effective way to lower your self-employment tax. Surprisingly, many people still fail to claim all the business expenses they qualify for, which can result in overpaying taxes.
It's crucial to note that you can claim these write-offs on top of the standard deduction, so don't skip it, even if you earn less than $12,000. The more you can shave off your tax bill, the better it is for your financial situation.
Business expenses are the key to reducing your self-employment tax, so make sure to claim as many as you reasonably can for your type of business. Don't leave any money on the table!
As an example, let's say you are an artist who sells pet portraits on Etsy and earns $50,000 a year in self-employment income. If you report the entire $50,000 as taxable income, you'll have to pay the 15.3% self-employment tax on the entire amount, which translates to a substantial $7,650 in taxes.
However, by claiming business expenses that you've incurred while running your business, such as the cost of paint, brushes, and canvases, you can significantly reduce your taxable income. This can include other expenses such as software subscriptions, a portion of your rent for your home office, packing and shipping supplies, new equipment, and business travel costs.
By doing this, you can write off $15,000 as business expenses and pay taxes on only $35,000 of your income, reducing your tax bill by $2,295. This applies to all businesses, both big and small, and can help you save a significant amount of money.
It's also important to note that freelancers and self-employed small business owners can take advantage of unique deductions not available to regular employees. By researching and claiming all the deductions available to you, you can further minimize your tax bill and keep more of your hard-earned cash.
You may be surprised to learn that you can deduct your self-employment tax from your income tax. While it may seem too good to be true, it's a legitimate tax deduction.
As a self-employed individual, you are responsible for paying both the employer and employee portion of the FICA taxes. However, you can write off the employer's portion of these taxes when you file your income tax return. This deduction is justified by the fact that you are both the employer and the employee in this scenario.
This tax deduction is not sneaky or illegal. In fact, it's built right into your Schedule SE. If you forget to claim this deduction, the IRS may even send you a letter to correct the mistake and refund the difference. So, make sure to claim this deduction when filing your taxes to minimize your tax bill legally.
The Qualified Business Income (QBI) deduction is a tax break that many 1099 workers and freelancers don't realize they're missing out on. Introduced in 2018, the QBI deduction allows self-employed individuals, freelancers, and most small business owners to take up to 20% off their taxable income, without having to answer any questions.
To qualify for the full deduction amount, you must earn less than $326,600 when married, filing jointly, or less than $163,300 when filing any other way. This deduction can save you a significant amount of money on your taxes, simply because you're self-employed.
It's important to note that this deduction is not a tax loophole. It's a legitimate tax break that can help you reduce your tax bill legally. So, make sure to take advantage of this deduction when filing your taxes and cut 20% of your taxable income.
As a full-time W-2 employee, your employer usually pays a portion of your health insurance plan. However, as a self-employed individual, you can still take advantage of the same tax benefits when paying for health insurance.
You can deduct the cost of health insurance on your taxes, but it works differently than most business expenses. You don't list it on your Schedule C with the rest of your write-offs because it lowers your income tax instead of your self-employment tax.
It's worth noting that self-employed individuals often pay more for health insurance than traditional employees. Being able to deduct the cost of your health insurance on your taxes, regardless of which tax it reduces, can be a significant savings opportunity. So, make sure to take advantage of this deduction and reduce your tax bill legally.
Another way to lower your taxable income is by contributing to your retirement account. As a self-employed individual, you have the option to create various retirement plans, including SEP-IRAs, SIMPLE IRAs, and Solo 401(k)s.
Contributions to your retirement account can defer taxes on the money you put in, until you withdraw from the account. While not every 1099 worker may make enough to contribute to a retirement account, full-time freelancers should consider this as a long-term investment.
By investing in a retirement account, you can not only save for your future but also lower your taxable income. So, make sure to explore your retirement account options and take advantage of this tax-saving opportunity.
To take advantage of these tax-saving opportunities, you need to fill out the appropriate tax forms. While dealing with paperwork may not be the most exciting task, it's worth it to save money on your taxes.
If you prefer to file your taxes on your own, make sure to educate yourself on the tax deductions and credits available to you. Don't miss out on any opportunities to save on your taxes. By taking advantage of these tax tricks, you can reduce your taxable income and save money legally.
To claim your business write-offs, you need to fill out Schedule C. This form is where you will report your earnings from self-employment and write off your business expenses to determine your total taxable income.
If you're not familiar with how to fill out Schedule C, check out our complete guide to Schedule C for more information. This guide can help you understand the form and make sure you're claiming all the tax deductions you're entitled to. By properly filling out Schedule C, you can reduce your taxable income and save money on your taxes legally.
When filling out your taxes, Schedule SE is another form you will need to complete. This form is used to calculate your self-employment tax based on your taxable income.
By filling out Schedule SE, you can also determine how much of your self-employment tax you can use to save on income taxes. This form works in conjunction with your Schedule C to help you take advantage of all the tax-saving opportunities available to you. So, make sure to complete Schedule SE properly to maximize your tax savings legally.
To claim your QBI deduction, you will need to fill out Form 8995. This form is used to calculate the deduction and claim the savings on your taxable income.
If your taxable income is higher, more than $170,050 for single people and more than $340,100 for married couples, you will use a different version of the form called Form 8995-A. This form allows you to calculate the deduction and claim the savings on your taxes for higher-income earners.
In addition to the other tax forms mentioned earlier, you will also need to complete Form 1040 to claim your other income tax savings. This form is used to claim tax savings on your health insurance and retirement contributions.
Make sure to include all the relevant information and fill out the form accurately to take advantage of these tax-saving opportunities legally.
Remember, there's no secret or sneaky way to deal with the IRS. However, by educating yourself on the tax deductions and credits available to you and filing your taxes accurately, you can save money on your taxes legally and reduce your taxable income.
This post is for informational uses only and is not legal, business, or tax advice. Please consult with an attorney, business advisor, or accountant with concepts and ideas referenced in this post. Balance Pro assumes no liability for actions taken in reliance upon the information contained in this article.
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