Self-employed workers who quit salaried jobs last year in the “Great Resignation”—the biggest corporate exodus on record—may find themselves reminiscing about the good old days on a payroll as they prepare their 2021 tax returns.
The simplicity of having taxes automatically withheld from a regular corporate paycheck is a stark contrast to the labyrinth of documentation, calculations, and rules that gig workers must navigate to ensure compliance and determine how much tax they owe.
“There’s a big issue with people not being familiar with the rules or not having necessary records to figure taxable income,” says Garrett Watson, a senior policy analyst at the Tax Foundation. “This can lead to either an overpayment or underpayment of taxes.”
Underpaying isn’t advisable. The Internal Revenue Service is notoriously hawkish when it comes to self-employment income, and that’s not surprising: Some 58% of the $630 billion annual “tax gap”—the difference between what the IRS collects and what it is owed—is due to underreporting by independent workers such as freelancers and owners of partnerships and LLCs, according to the nonprofit Committee for a Responsible Federal Budget.
Self-employed workers earning more than $100,000 a year are more than twice as likely to get audited than salaried workers, and the audit rate rises as incomes go up.
Brace for the sting of self-employment taxes.
While income taxes for all workers kick in once earnings exceed $12,550 for singles and $25,100 for couples under age 65, independent workers must report income and pay the 15.3% self-employment tax on net earnings—pay minus deductible expenses—exceeding $400.
This includes a12.4% Social Security tax on income up to $142,800 and a 2.9% Medicare tax with no income limit. Earnings of more than $200,000 for singles and $250,000 for couples are subject to an additional 0.9% Medicare tax.
Salaried workers also pay Social Security and Medicare taxes, but they split the total 15.3% with their employers and their shares—called payroll taxes—are automatically deducted from paychecks.
The IRS attempts to bring parity between all workers by allowing gig workers to deduct half of the self-employment tax. But that deduction alone doesn’t fully offset the gig workers’ outlay, says Meghan Saunders, an enrolled agent in Towson, Md.
“A deduction reduces taxable income, but it’s not a dollar-for-dollar credit for taxes paid,” she says, adding that most gig workers pay a good bit more of these taxes than do salaried workers.
Pay estimated taxes quarterly.
If you expect to owe at least $1,000 in taxes, the IRS requires estimated taxes to be paid quarterly over a tax year. By now, gig workers should have paid their estimated 2021 income and self-employment taxes.
If you didn’t pay quarterly, you’ll owe your entire income and self-employment tax bill—plus any late penalties—by this year’s April 18 tax-filing deadline.
Many folks will find themselves in a tight spot if they haven’t been stashing a portion of their wages to cover taxes. “A lot of gig workers get earnings transferred to their bank accounts and spend it all,” says Terry Dickens, a senior manager at Moss Adams, adding that a pay-as-you-go approach can prevent a big tax shock during the filing season.
Quarterly tax payments are based on a prior year’s income, so while preparing 2021 returns you can calculate your first estimated quarterly tax payment for 2022—which also is due on April 18.
Round up income records.
Depending on sources of income, gig workers often need to round up a plethora of income records—unlike salaried workers who receive a tidy W-2 listing earnings.
Traditional companies issue Form 1099s. Hiring platforms such as Uber, Lyft, and DoorDash issue Form 1099-Ks for workers who had more than 200 transactions or earned more than $20,000. (For 2022, this IRS threshold drops to $600 as a way for the agency to track earnings of a growing number of gig workers and to help with enforcement efforts.) Other folks may only have bank and personal records to report earnings.
Tally deductible expenses.
A bright spot for gig workers is that, unlike salaried workers, they may qualify for qualified business income deduction on income of up to $164,900 for singles and $329,800 for couples, and job-related expenses can offset income.
But even perks aren’t as straightforward as taxpayers might hope, Dickens says. “If you take a business prospect to a baseball game, that ticket isn’t deductible. If you buy a hot dog, that expense is usually 50% deductible, but for 2021 it is 100% deductible,” Dickens says. “It can be confusing.”
Beyond the deductions for qualified business income and self-employment taxes, don’t miss a host of others.
Expenses directly related to work—a lawn mower for a landscaper, software for an accountant—are fully deductible, as are health-insurance premiums and pretax contributions to a simplified employee pension plan, or SEP IRA.
Costs related to entertaining aren’t deductible, but business restaurant meals are fully deductible for 2021 and 2022 as part of pandemic relief efforts to buoy restaurants.
If you use your car for work, consider two options: Deduct 56 cents for every work-related mile driven or multiply the percentage of work-related car use by total annual car expenses, such as gas and repairs. If expenses were $5,000 and 25% of your car use was for work, you can deduct $1,250.
There are also two ways to claim home-office deductions. The simplest is to multiply the square footage of your office—with a cap of 300 square feet—by $5. For 200 square feet, you can claim a $1,000 deduction.
“The other method is to deduct costs attributable to your home office,” says Angela Anderson, an Atlanta accountant at JustAnswer.
If your office occupies 10% of your home, you can deduct 10% of expenses such as utilities, mortgage interest, property taxes, and home repairs.
“Use whichever method is more beneficial,” Anderson says. “Whatever you do, keep good records.”
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