Whether you put your car to work driving for Uber and Lyft, put your writing skills to work creating quality content for business owners or put a lifetime of knowledge to work as an industry consultant, doing your own thing feels really good. What does not feel good is the big tax bill that often accompanies life as an independent contractor.
When you work on your own, you are on the hook for additional taxes that traditional employees do not pay – like the employer portion of the Medicaid and Social Security tax. And without regular withholding from your employer, you are also required to carefully track how much you owe – and pay up in quarterly installments. If you wait until the end of the year to settle up with Uncle Sam, you could be on the hook for additional taxes and late payment penalties, so tax planning should be an integral part of your business operations. Glenn Sandler, CPA, the Founder and CEO of G.I. Tax Service, encourages you to plan ahead.
Whether your independent contractor activities constitute your full-time occupation or represent a smaller portion of your earnings, proper tax planning is essential. If you do not want to be surprised by a big tax bill when April 15 rolls around, you need to start planning now.
The good news is that there are a number of tax deductions independent contractors can take advantage of, and those deductions could substantially reduce your tax bill and make your life easier in the process. If you feel up to the challenge, you can research these deductions on your own and look for ways to save. If not, you can hire a tax accountant or other professional to do the legwork for you.
Health care is one place where independent contractors can take advantage of some pretty substantial deductions. If you are not eligible for health care through your employer, you may be able to deduct a large portion of the money you spend to buy an individual plan. If your income is low enough, you may also be eligible for government subsidies to make buying an individual plan easier.
Opening a health savings account is another way for independent contractors to cut their tax bills and protect themselves from high out-of-pocket expenses. Pairing a health savings account with a high-deductible health plan is a great way for freelancers and independent contractors to reduce their tax bills and their insurance premiums.
Since the monthly premiums on these high-deductible plans are generally lower, eligible freelancers can save money on the front end. And by putting tax-deductible money in their health savings accounts, independent contractors can reduce their risk on the back end. It is as close to a win-win as it is possible to get in the complicated world of health care and health insurance coverage.
Independent contractors, business owners and freelancers are also eligible for a number of self-directed retirement plans, and contributions to those plans could substantially lower their taxable income. Those who work for others may have access to a 401(k), and independent contractors can open their own Solo 401(k) accounts to put money aside and lower their tax bills.
The contribution limits on Solo 401(k) plans are quite generous, making the plan a great choice for eligible freelancers and independent contractors. There are some complicated rules to follow, however, so it is best to seek advice from a tax professional before setting up the plan.
Independent contractors can also set up other retirement plans, like a SEP-IRA. The contribution limits on these plans are lower, but they are less complicated to set up and contribute to. As with any retirement plan, it is important to review the rules and understand them – and to keep meticulous records along the way.
Life as an independent contractor can be great, but no one likes the high taxes that come with that status. If you want to enjoy the freedom and flexibility of running your own business, you need to make smart tax planning a big part of your operations. A CPA who has worked in the tax industry for years, Glenn Sandler suggests planning ahead and researching the tax code is the best way to avoid unpleasant surprises and keep your tax bill as low as possible.