Tax Planning for Self-Employed and Side-Gig Workers

Tax Planning for Self-Employed and Side-Gig Workers

March 04, 2024

Whether you’re taking on freelance assignments to supplement your income from your regular job or you’ve decided to embrace the gig economy full time, you’re responsible for managing your income, expenses, and tax obligations.

Federal and state income taxes and Medicare and Social Security taxes aren’t usually withheld from payments you receive for non-wage income, so it’s up to you to make sure you pay these taxes yourself on a quarterly basis.

However, one benefit of being your own boss is that you can take advantage of many tax breaks that could lower your overall tax burden.

The IRS self-employment center is a good resource to get information on tax requirements for freelancers and gig workers, but here are some key issues to consider if you plan on being your own boss some or all of the time. 

Business deductions

 As a self-employed worker, you may be able to deduct business expenses from your self-employment income. These may include money you pay out of pocket for: 

  • Equipment and supplies;
  • Office space rent;
  • Cell phone services;
  • Advertising and marketing costs (including Facebook and Google ads); and
  • Client and prospect-related entertainment expenses.

Vehicle expenses

If you use your own vehicle to provide your services or meet with prospects and clients, you may be able to deduct mileage or expenses for fuel, repairs and maintenance.

Home office expenses

If you operate your business out of your home, you may be able to deduct a portion of expenses for mortgage interest, insurance, utilities, repairs, and depreciation. The IRS offers resources that explain how to calculate these deductions.  

Health insurance deductions

If you’re self-employed and aren’t enrolled in an employer health insurance plan, you may be able to deduct a portion of premiums you pay for qualified health insurance you purchase on your own through or your state’s health insurance marketplace. 

Retirement contributions

If you’re fully self-employed, you can’t contribute to an employer-sponsored retirement plan, but you can contribute to a traditional IRA or Roth IRA to save for the future.

Depending on your income, contributions to traditional IRAs may be tax deductible, whereas contributions to Roth IRAs are made after-tax but grow tax-free. Roth IRA distributions aren’t taxable if you’re age 59½ or older and you have owned the account for at least five years.  

If you want to make tax-deductible contributions beyond what IRAs allow, a SEP-IRA allows sole proprietors to contribute up to 25% of their business compensation or $69,000, whichever is less.

Other tax-advantaged retirement plan options for smaller businesses and sole proprietors are available. Meeting with a financial advisor can help you weigh the pros and cons of each option and figure out which, if any, make sense given your situation.

Figuring out your business profits (or losses)

When preparing your annual tax returns, you’ll want to enter all gross proceeds and qualified deductible business expenses on IRS Schedule C. Completing the form will show you your overall profits (or losses) from your business.

You’ll report this amount on IRS Schedule SE, which you'll use to calculate what you may owe in Social Security and Medicare taxes. 

Calculating and paying taxes

If you think you'll owe more than $1,000 in federal income taxes for the year, you should be making quarterly tax payments. 

There are several ways to calculate your payments. None are "one-size-fits-all" solutions, especially if this income comes from a side gig and you're having taxes withheld from your wage-earning job.  A tax professional can help you figure out the appropriate amount.

Sometimes it's better to overpay rather than underpay. If you pay too much, you may get some of it back as a refund when you file your tax returns. But if you underpay, you may be hit with IRS underpayment penalties. 

If you want to send quarterly tax payments by mail, you need to include copies of  IRS Form 1040-ES. Or, you can pay online using the IRS payment portal.

Don’t forget state tax payments

If your state has income taxes, you should make quarterly payments as well.

Document everything

Generally speaking, self-employed workers have a higher risk of being audited by the IRS than those who earn wages. Your audit risk grows even higher if your business reports a loss in a given year.

The key to defending against an audit is meticulous documentation. Keep receipts of every business-related transaction, including retail purchases and utility bills. If you deduct client-related entertainment expenses, keep a diary of each event. If you deduct mileage for trips to meet with clients and prospects, keep a detailed log of every meeting and the miles you drove each way. You'll need to present this documentation if the IRS (or your state) questions any of your business expenses.

Hold on to these receipts, logs, and diaries for at least three years after filing your returns.

Get professional help

Managing your taxes as a sole proprietor or side-gigger is rarely straightforward. You can get into trouble with the IRS and your state if you make mistakes, so it might be wise to work with a tax professional to ensure you’re doing everything right.

This material has been provided for general informational purposes only and does not constitute tax, legal or investment advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a qualified tax professional and/or financial advisor regarding your situation.

This article was co-authored by Dan Flanagan, Jeffrey Briskin and Commonwealth Financial Advisors. Dan is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or  Jeffrey Briskin is Director of Marketing at Canby Financial Advisors. 

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