The gig economy is booming. The COVID-19 pandemic has created a demand and an opportunity for workers to profit off their skillsets outside from traditional employment. In fact, country music star Dolly Parton even updated her classic hit “9 to 5” to speak to the growing number of entrepreneurs who are getting their side hustle on after clocking out of their day job. Now more than ever, people are working “5 to 9” and building a business from their own know-how.
Anyone who earns income directly from clients — as a contractor, freelancer or small business owner — and doesn’t have an employer that withholds money from their pay for tax purposes, is generally classified as a self-employed worker by the IRS. If you’re self-employed, it’s important to understand how taxes work, so you can avoid owing more than your fair share to the government. Being in business for yourself can lead to higher taxes and more complex tax returns than you bargained for.
The self-employed and tax withholdings
Self-employed workers are responsible for paying taxes through estimated tax payments. These estimated payments must be sent directly to the IRS on a quarterly basis — by April 15, June 15, September 15 and January 15 — if you expect to owe at least $1,000 in income tax at the end of the year. Failure to plan properly and pay enough estimated taxes during the year can result in a tax penalty and a large surprise tax bill. By paying at least 90% of the tax you owe or 100% of the total tax owed from the previous year, the IRS will typically not assess a penalty.
If your hustle isn’t very lucrative (yet), a net income of $400 or more from self-employment means you can expect to pay up on those earnings — even if you’re already paying taxes through your traditional job. For example, if you work as an employee year-round, but you take on small contract jobs on the side to make extra cash, that revenue must be reported as self-employment income when you file your tax return.
Traditional W-2 employees split the cost of paying into Social Security and Medicare with their employers, but self-employed workers must pay the full amount themselves. As a self-employed worker, you’re on the hook to pay the self-employment tax, which goes toward Social Security and Medicare, in addition to normal income tax.
There’s no avoiding Uncle Sam
Preparing your annual return and calculating quarterly taxes as a self-employed worker can be tricky. That’s why the experienced CPAs at NJ accounting firm Magone & Company can help you navigate tax laws and ensure tax compliance. We’ll also help you maximize your return, saving on any tax write-offs you may be entitled to as an independent worker. Send us a message or call 973-301-2300.