Tax Tips: Advice For Independent Contractors

An independent contractor has many more tax considerations than a person who is merely an employee. Here are some tax tips.

An independent contractor has many more tax considerations than a person who is merely an employee. Here are some tips to help independent contractors stay on top of tax issues.

Maintain your independent contractor status. The IRS might rule that you are actually an employee if you primarily work for one client. This is especially true if you work on the client's premises, with their equipment, and under their direction. If you are ruled an employee, you will lose the ability to deduct your expenses while not gaining any benefits that a regular employee would have. It is best to have several clients and use your own equipment if possible.

The IRS may rule your business a hobby if it does not show a profit in 3 out of 5 years. It is more likely to make this ruling if the business is not your only or primary form of income. If this happens, you will only be able to deduct expenses up to the amount of any income you make from the business. However, even without making a profit you may be able to prove that your enterprise is a business and not a hobby if you run it in a businesslike manner. Some ways to demonstrate this are:

1. Have a business plan.

2. Have a separate bank account for your business and never intermingle business and personal finances

3. Have a separate phone line for your business.

4. Keep good records of all business activity.

5. Take professional seminars and courses in your field.

6. Take courses in business or consult with experts on how to grow your business.

7. Maintain a consistent and professional business image, including business cards and advertising.

Pay your quarterly taxes on time. Since an independent contractor does not have taxes deducted from client checks, you must pay estimated taxes on a quarterly basis if your tax liability for the year will be more than $1,000. If you omit to do this, the IRS may penalize you. The due dates for quarterly taxes are usually the fifteenth of the month in January, April, June, and September each year. Check with the IRS for the exact dates each year. If you do not make the payments by the due date or do not pay enough estimated tax payments to cover most of your tax liability for the year, the IRS may penalize you.

Be aware that not only do you have to pay your portion of Social Security taxes as an employer would; you also have to pay the employer's portion. Fortunately, you can deduct the extra portion from your income when you file your Federal income tax return.

Keep careful records of all your expenditures so that you do not miss any deductions. Even if you don't do your own bookkeeping, you can use a simple spreadsheet in order to track your expenses. Be sure to keep all receipts as backup for your records.

Be especially careful to keep good records on usage of cars, computers, and cell phones if you also employ these items for your personal use. The IRS is especially vigilant in checking the deductions for these items. Keep a separate log for each of these items showing the miles driven for business in the car, the hours the computer is used for business, and the business calls made on the cell phone.

Some equipment can be expensed as soon as it is bought instead of being depreciated. This can will you a much lower tax liability in the current tax year. Currently, the limit on the amount that can be expensed in any year is $100,000. Computer software can also be expensed; formerly it had to be depreciated over several years. Be aware that the IRS has been known to disallow tax benefits for a previous year if it later finds that the expensed equipment is not being used more than 50% of the time in the business.

Get a separate phone line for your business if you do not have one already. Not only will it enable you to deduct your telephone costs, something you cannot do if you use your personal line for business, it helps to demonstrate that you are running a business, not a hobby.

You may be able to deduct part of the expenses for your home if your primary office or place of business is in your home. The deductions can include part of your rent or mortgage payments, depreciation, utilities, insurance, real estate taxes, and repair costs. The part of your home that is used must be meet one of the following criteria:

1. Be used on a regular and exclusive basis for the business.

2. Be used to meet with clients or customers.

3. Be a separate structure on your property, not attached to your home.

4. Be used to store inventory or sales samples.

If you own your home and choose to use the home office deduction, be aware that when you sell the house, you will have to reduce the cost basis of the home by the depreciation on the house. This is true even if you did not take a deduction for the depreciation. You may only deduct depreciation up to your gross profit from the business less any other expenses from the business and the deductible mortgage interest and taxes. However, you may carry over any unused depreciation expense forward to the next tax year.

Keep good records, conduct your business like a business, and be diligent in keeping up with tax changes, and your financial life as an independent contractor will be much smoother - at least where taxes are concerned.

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