By Christopher F. Davis, PhD
Tax season; when accountants across the country are called upon to assist millions of Americans with their taxes. In the last few years, a nice investment could have been made in companies that have created software to assist in this process, and the complication of independent contractor taxes has been compounded over the years. In this article, I want to address those who are receiving 1099 forms, including many self employed individuals living in the United States. We are generally hammered in taxes as we are responsible for federal, state and local income tax (depending on where you live), as well as the dreaded self-employment tax. The IRS will match the 1099 form you received and claim with the one that the each paying client sent to the IRS. There’s no way around it, Uncle Sam wants his cut.
Independent Contractors and The 1099
Now as many of us are considered an independent contractor, we will receive a 1099-MISC form from any company you provided services for so long as the payments were at least $600 for the prior year. If you did not receive a 1099 in the mail, then you should contact the company you provided services for immediately. Bear in mind that if you made less than $600 then you will not receive this form, generally speaking. But you still need to report the income on your tax filing. Of course, the rule is that you need to report any and all income earned even if it is under the $600 threshold pretty much no matter who or what the source of the payment. The IRS wants to know and expects their share.
Once you get the 1099-MISC form, you can then begin the process of putting together your tax return. For many independent contractors, this means filling out a Schedule C, which tallies up the income earned and any deductible expenses. There will also be a need to file a Schedule SE, which accounts for Social Security and Medicare payments (i.e the dreaded self-employment tax).
Either Hire A Tax Professional Or Use A Tax Software
Independent contractor taxes are tough. The safest way to ensure you will pay only what you must is to hire a strong tax professional. This can be very costly for the best of services. For most of us the good news is that tax preparation is a fairly easy process, especially if you use tax prep software like Intuit’s (INTU) TurboTax or Blucora’s (BCOR) TaxACT. Both are efficient. You can also consider H&R Block’s (HRB) Tax Software, formerly known as Tax Cut. In the last five years those preparing their taxes with such software has grown. The stocks of these companies have responded in kind (figure 1).
Figure 1. Performance Of Intuit, Blucora and H&R Block Stock In The Last Five Years.
As we can see in the figure, both INTU and BCOR have been solid investments in the last five years, although HRB has had issues with its brick and mortar establishments, weighing on the stock. It has come on a bit in the last two years however. The great thing about the software is that you can work on your taxes at your leisure in the comfort of your own home. Each provides a convenient wizard to help enter the information. As more and more people turn to these types of software, the companies will continue to rake in revenues. After all, there are only two things certain in this world, and taxes are one of them. And, even upon death, the IRS can tax you again!
A Point About Quarterly Estimated Payments
If you are making enough as an independent contractor to be on the hook for $1,000 or more in tax liability for the year (after allowable withholdings/deductions), you will need to make estimated payments quarterly because you will not have any automatic withholding of federal income taxes and self-employment taxes (such as for Social Security and Medicare) to pay. Your tax software usually includes calculators to determine what is owed. If you fail to do this, there are penalties assessed. Generally speaking if you hold a full time position and usually get a tax refund, assuming contracting is a side business, you are generally not going to have a tax liability. However, on this matter it is best to consult a tax professional (or even the IRS if you are brave) to determine if you will need to make quarterly payments.
How To Offset Liabilities Using The Software
One way to combat the army of IRS agents when doing your independent contractor taxes is to claim deductions you are legally entitled to. For the Federal Income Tax portions, there are benefits to marriage, homeownership, having children etc. I will not cover those here, but do want to delve into how we can reduce liabilities with Schedule C as independent contractors. The tax software can help identify these items through a series of questions and possibilities given your situation. But it helps to be prepared so you do not overlook anything.
What you need to do is to find and keep track of deductions. You need to be thorough and not rule anything out. There are lots of opportunities to reduce your taxable income with deductions but the key issue is that it will depend on your business. Just some of the items you need to consider include but are not limited to: supplies purchased necessary to do the work, advertising costs, commissions paid, professional service fees or certification/educational charges, any license fees, subscriptions to professionally related publications or services, rent (including home office deduction), insurance costs, memberships to professional organizations, any credit card fees, business-related gifts, and fees for tax related services/software. Those are some major ones. Other potential deductions to consider include car expenses, either with a standard mileage rate or to use the actual expenses. Related to the purchase of something like supplies necessary to do the work, you can consider high ticket item depreciation deductions. If you purchase something that will last more than a year you will probably need to depreciate the value over time. You can also take a one-time deduction for most things, unless they will last substantially beyond a year. Don’t forget the home office deduction and deductions for power, heat, cable/internet as a percentage of the use for business. If you are entitled, take it. But be smart about it, don’t stretch the truth or it could lead to headaches down the road.
Accounting Software and Other Key Considerations
Regardless of the deductions you elect on your independent contractor taxes, it’s a good idea to get an accounting system, such as Quicken QuickBooks, another INTU software, or even keeping up on it using Microsoft (MSFT) Excel or even Access. I recommend utilizing a full financial program though. Using such an application will make the tax process much easier (and is fully tax deductible!). But the most important things to do is to make sure you get and keep receipts for everything. It’s the best defense in case you are ever the subject of an IRS audit. If purchases were made online, I generally recommend printing a copy of the order and keeping the shipping receipt, just in case Uncle Sam and his agents decide to get picky.
Another way to reduce taxable income is to get a retirement plan going. Not only will it help you escape some Federal Income Tax, it is also a good way to help provide for a more financially secure future. One option is to fund an individual retirement account, or IRA. The IRS also has a number of programs for the self-employed, such as the SIMPLE IRA, SEP IRA or a solo 401k.
Are you sure you actually are self employed? Perhaps your ‘business’ may not really be a business at all. Instead, it may just be a hobby. In this case, the IRS could back audit you and you could be on the hook for paying prior deductions, including penalties and interest. It could be devastating. You don’t want it to be a hobby if you have claimed it as a business expense. A simple way to ensure it is a business is to ask, “am I in this to make a profit?” If yes, you are ok. For the IRS, there is one simple rule to make sure your business is not classified as a hobby. You need to make sure you generate profits for three out of every five years. Some who work may be doing so as a hobby, particularly the low volume writers that cover one or two things. Just be cautious about your status.
Keep Your Money, And Get Paid To Do It!
I have covered a few key considerations here as it relates to independent contractor taxes. I want all of my fellow Americans and anyone else reading this article that pays self-employment taxes to keep the fruits of their labor. I have one more point to consider. Depending on how complex your taxes are, I recommend using a professional. Those with millions in assets are probably best to go this route. For many others, one of the aforementioned software packages should suffice. That said, you can consider investing in one of the names. HRB has been held back, but thanks to revamping its software, cleaning up its brick and mortar establishments and a new advertising campaign, I think it’s a good buy as it sports a nice 2.7% yield and has growth prospects. It’s often traded institutionally so bad news could send the stock down quickly, or up sharply. BCOR is a little expensive right now on a multiple basis and a forward basis and does not pay a dividend. Its traded with volatility this year. However, the stock is oversold year to date and is down 15%. If it can deliver some strong earnings, I suspect it could snap back. My favorite of the three is INTU. I use both their accounting software and TurboTax. The company began paying quarterly dividends a few years ago and has raised the dividend each year, and currently has a 1.1% yield. The stock is down 6.5% year-to-date, but with the growing trend of those using their software products, I suspect this may be a buying opportunity. It has acquired several companies in the last year to strengthen its brand. For the last five years, the stock has delivered a 200% return. If you can acquire shares under $70.00, it may make for a good starting point for an investment in this name.
independent contractor taxes can be tough. Keep your hard earned money by exploring some of the strategies suggested here. Consider getting paid to keep your own money by looking into the stocks of companies offering tax preparation and accounting software.
Dr. Christopher F Davis is not a certified tax professional. He has studied Tax regulations and prepared tax returns for numerous friends and family members over the years. The information contained in this article is for educational purposes only. It should not be construed as tax advice; rather it is intended to highlight key considerations for independent contractors. Christopher F. Davis utilized Intuits’ TurboTax software, or H&R Block’s software. Everyone’s individual needs are different. Please consult with a tax professional or the IRS when considering estimated payments or deduction entitlements.
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