1099 Income and Taxes

These last few years have been filled with transition for lots of people.  If your transition has included changes in your employment, please keep reading.  If you have transitioned from a job where you were getting paid as a “W2 employee” and are now getting paid as a “1099 contractor”, there will be some big impacts to your tax bill.  Maybe you still have your W2 job but you picked up a side hustle for extra income.  Maybe you decided to quit your W2 job and start your own business, taking payments from clients/customers.  The bottom line is, if you’re getting paid via anything other than a W2, you need to understand what your tax impacts will be.

Scary Statistics

According to the Bureau of Labor Statistics, 22% of all small businesses fail in their first year – many times it’s due to not understanding the tax implications and therefore getting stuck with a very big bill from the IRS in April.  This statistic can be avoided with a little bit of knowledge and planning.

How it Works (You can’t blame the IRS!)

The IRS uses a “pay as you go” system.  When you are a W2 employee, taxes are withheld from your paycheck based what you indicate on your W4 form with your HR department.  So essentially you are “paying in” each pay period.  Then, depending on the other aspects of your tax situation (number of kids, filing status, deductions and credits, etc), you may actually get a refund when you file your taxes.  If you didn’t withhold enough, you may have to pay more.

It is very different when you are receiving 1099 income.  With 1099 income, there are ZERO taxes taken out.  You are responsible for estimating what your tax bill will be come April.  Unfortunately, this surprises a lot of people.  Let’s say you start a new side hustle and are getting paid via 1099.  You are so excited to have extra money coming in and you spend all of it.  You also don’t realize that you should be tracking your expenses to be used as deductions on your taxes.  At year-end, you receive a 1099 statement that shows the total amount you were paid for the whole year.  In the process of doing your tax return, you realize that you owe the IRS thousands of dollars in taxes on that income.  The income that you’ve already spent.  Ouch.  Now you have to set up a payment plan with the IRS because you haven’t planned properly, including interest and late fees.  It doesn’t have to be this way!

Be Smarter

In order to avoid all this agony come tax time, here is EXACTLY what you need to do:

1. Even if your 1099 income is a side hustle, think of it in terms of you running your own business.
2. Keep good records.  Keep a list of how much you’re being paid, and keep track of ALL of your expenses incurred while earning that income.  You can deduct business expenses on your taxes to help reduce your tax bill.
3. Project your income for the year and deduct your projected expenses from that income.  The number that remains (your Net Income) will be the amount you are taxed on at your personal tax rate (for a sole proprietor or single-member LLC).
4. Review your personal tax situation and factor in your Net Income from your business.  If you think you will owe more than $1,000 in taxes when you file, you should be paying quarterly estimated taxes to the IRS.
5. Enlist the help of a CPA or accountant to guide you through these calculations and help you figure out when and how to make the quarterly payments to the IRS.  If you fail to make quarterly payments, the IRS will charge you penalties and interest at tax-time if you are waiting until April to pay them a whole year’s worth of taxes (i.e., you have not followed their “pay as you go” system).

Capture all of those Expenses

One of the benefits of receiving 1099 income is that you can deduct business expenses against your income. The key is understanding what business expenses you can deduct, and then keeping good records of those expenses.  A great way to do this by setting up a separate bank account to receive your income and pay your business expenses.  This makes it very easy to download the activity from your bank when it comes to tax-time.  If you’re not sure what can be deducted, the IRS has a great list on their website https://www.irs.gov/publications/p535

You’ve Got This!

Receiving 1099 income can be a great thing.  With some knowledge, planning, and organization, you can avoid the pitfalls when it comes to your tax bill.