Taxes are a bigger headache for the self-employed than they are for traditionally employed workers. Most of the latter group just have to wait for their W-2s to arrive, fill out their tax returns, and sit back and wait for any refund. But self-employed workers need to gather all their 1099s, keep track of all their business deductions, and remember their estimated taxes throughout the year.
All those extra steps leave a lot of room for error. Making a mistake could be costly -- or worse, bring the IRS calling. Here are four of the most common tax mistakes for self-employed workers and those with side jobs.
1. Failing to set aside money for taxes
Traditionally employed workers have taxes taken out of every paycheck, but self-employed workers don't have regular paychecks the government can take money from, so they must set aside money for taxes on their own. If you're one of them, don't try to hide income from the government. That's a sure way to get audited. If you receive a 1099 from a company you worked for, the government already knows about that money, so if you don't report it, that sets off alarms.
You can use this worksheet to determine how much you'll owe in estimated taxes if this is your first year being self-employed. In future years, your tax returns should give you an idea of how much you must pay quarterly to avoid penalties.
Once you know what your quarterly tax bill will be, you can budget to meet that goal. It's not a bad idea to set aside a little extra, just in case your tax bill ends up being larger than you expected at the end of the year. I use a separate savings account for my tax money so I don't accidentally spend it, but you can keep all your money in one account as long as you know how much you need for taxes.
2. Failing to pay taxes quarterly
It's a good idea to pay your taxes on your self-employment income in estimated quarterly payments. The only time you might not have to is if a side job only provides a small amount of income and you expect a large refund from your regular job. That refund will probably offset the amount you'd owe from your extra job, so you may not need to pay quarterly taxes, though you can if you're worried about ending up with a bill at tax time. If you don't pay estimated taxes and end up owing a lot, the IRS could charge you an underpayment penalty.
Quarterly taxes are due on April 15, June 15, Sept. 15, and Jan. 15 of the following year. If one of those days happens to fall on a weekend, the due date is moved to the next weekday. Set reminders to make your payments on time. You can either mail a check to your state and the federal government or you can have them withdraw the money directly from your bank account.
3. Failing to claim all the deductions you qualify for
One of the upsides to being self-employed is that you get to write off your business expenses and reduce your taxable income. You could even move into a lower tax bracket and lose a smaller percentage of your income to the government.
Acceptable business deductions include business travel, a home office, internet and phone services, office supplies, advertising costs, and even mileage on your vehicle if you're driving for a business-related purpose. All of these expenses must be solely or primarily for business; you can't count your living room as a home office because that's not what it's used for most of the time. You also can't count a vacation as a business expense just because you stopped to chat with one client.
If you'd like to write these expenses off, you need to itemize your deductions, but this only makes sense if you believe your total itemized deductions will exceed the standard deduction for your tax filing status. For the 2019 tax year, the standard deductions are:
- $12,200 for single adults and married couples filing separately.
- $24,400 for married couples filing jointly and qualifying widow(er)s.
- $18,350 for heads of household.
Single adults can also add an extra $1,650 to their standard deduction if they are over 65 or blind, or an extra $3,300 if they meet both criteria. Married couples can add an extra $1,300 per spouse who is over 65 or blind, or an extra $2,600 for a spouse who meets both criteria.
If your self-employment deductions and any other personal tax deductions that you qualify for don't exceed these thresholds, you're probably better off claiming the standard deduction, but you won't know this until you calculate how much your deductions add up to.
4. Failing to keep proof of your deductions
You aren't required to submit any paperwork to prove your deductions with your return, but you're expected to have proof of your deductions on hand and present them to the IRS if you're audited. Acceptable proof includes receipts, bills, or credit card statements. Without the appropriate documentation, the IRS could disallow your deductions even if they were otherwise legitimate.
Get in the habit of saving your receipts and store them all in a folder so you don't have to track them down at tax time. Hold on to these documents along with your tax returns for at least three years or up to seven years if you claimed a loss for worthless securities or a bad-debt deduction.
After a year or two, you should become familiar with the extra tax hoops that come with being a self-employed worker. As long as you're careful to set aside money for taxes, pay your estimated taxes quarterly, and carefully track all of your deductions, you should be fine.