This message is for all you freelancers, gig workers, lodging hosts, online sellers, consultants, independent contractors and others who are in business for yourselves:
Now is the time to make moves to lower your tax bill next April.
There’s good news and bad news. People who are self-employed have opportunities to cut taxes that regular employees don’t have. The deadline for most moves is Dec. 31.
But if you’re new to freelancing, this process could bring unpleasant shocks. Tax confusion is rampant among gig workers and freelancers, according to Miguel Centeno, a managing partner of Shared Economy Tax, a nationwide firm specializing in this sector.
“Every day, these workers come to us knowing they’ve made money but having no idea what they do or don’t owe the IRS. Their confusion is costing them thousands of dollars, either in potential penalties or unused tax breaks,” he says.
The ranks of self-employed workers are growing, thanks to an explosion of online platforms such as Uber, TaskRabbit or Upwork that offer freelance work rather than traditional employment.
A recent independent study conducted by three economists working with the Internal Revenue Service found that from 2006 to 2016, the number of workers with self-employment income reported on IRS 1099 forms grew by 2.7 million, from 9.8% to 10.7% of all workers. Most of the growth was due to online platforms.
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For the IRS, the growth in self-employment is dangerous for tax revenue. This area has long been known for noncompliance, and the agency estimates that at least 25% of the total tax shortfall of about $440 billion annually stems from underpayments of income, Social Security, and Medicare taxes by self-employed workers. A large part of the problem is the lack of withholding on freelance payments and sometimes no reporting of them by businesses to the IRS—or the workers themselves.
Freelancers face dangers as well, such as stiff IRS penalties if they think income isn’t taxable because they didn’t get a tax form. And if they skip Social Security taxes, they aren’t building an earnings record, which affects their ability to collect benefits later on.
Here are key moves for self-employed workers to consider before year-end.
*Track income. Income earned from self-employment such as gigs or freelance work is taxable, but the paperwork doesn’t always show up.
Many businesses are required to send an IRS Form 1099-Misc both to the worker and the IRS if payments total $600 or more a year—but some firms ignore the law and others are unaware of it.
Other businesses, including many sharing-economy platforms that facilitate work and payments, have a loophole. These firms often use Form 1099-K to report payments to workers and the IRS. But they don’t have to send 1099-Ks until total payments exceed $20,000 and there are more than 200 transactions a year.
Some platforms send both 1099-Misc and 1099-K forms, which can produce strange results that are legal--at least for the platforms. Mr. Centeno has seen workers who have gotten a 1099-Misc for, say, a $700 bonus from a gig company, but not a 1099-K for, say, $18,000 of regular earnings. That’s because the $700 was above one reporting threshold while the $18,000 was below the other.
In this case, the worker is supposed to report the entire $18,700 as income, usually on Schedule C.
*Don’t forget Social Security taxes. Self-employed workers owe an amount equal to both the employer and the employee portion of Social Security and Medicare taxes. Then they get a deduction for half of it.
Before the deduction, the Social Security tax for 2019 for these workers is 12.4% of the first $132,900 of freelance income. The Medicare tax is 2.9% on all pay. Payments are figured as part of a filer’s income taxes.
*Check estimated taxes. Self-employed workers typically owe estimated taxes quarterly if their tax bill will be $1,000 or more for the year. There’s a penalty on underpayments.
Filing quarterly can be a bother, but there’s a good out for freelancers who also have W-2 wage income earned either by them or their spouses.
Freelancers can avoid owing quarterly taxes by increasing their withholding on wages. Even if a wage-earner doesn’t do this until late in the year, that’s OK—as long as the IRS gets about 90% of the total tax due by year-end.
*Get records straight. Good records are essential for freelancers. Mr. Centeno suggests tying them to a dedicated bank account, because receipts often fade. The time to work on them for 2019 is now, not next year.
Be especially careful with records for mixed-use assets, such as a vehicle used partly for business and partly for commuting and carpooling. Remember that commuting isn’t a deductible expense.
*Review deductions. Self-employed workers still get many deductions for expenses—such as travel, meals and equipment—that employees no longer can take following the 2017 tax overhaul.
If you’re a self-employed running coach, the cost of traveling to a marathon in Europe that your students are running in could be deductible. So could ballgame tickets for a freelance sports reporter.
Be prepared for IRS scrutiny if your deductions are for things others see as fun. Phyllis Kubey, an enrolled agent in New York City who prepares taxes for many performers, says she grills clients who deduct the cost of items like theater tickets.
Again, good records can pay off. An IRS auditor disallowed deductions by one of Ms. Kubey’s clients, a singer from Alabama, for traveling to New York City for auditions.
“On appeal, another IRS agent saw her meticulous spreadsheet of expenses,” says Ms. Kubey. “He said, ‘I concede.’”
*Look at depreciation. Your business expenses typically fall into two categories: those that are fully deductible right away, and those that have to be depreciated and deducted over a longer period.
Under current law, many items of equipment, such as a computer, or furniture for a room rented on Airbnb, can be fully deductible right away. But a bathroom renovation for the rented room might only be deductible over 27 ½ years.
Consider buying and setting up needed equipment by year-end to reduce taxable income, especially if profit has surged.
*Arrange health insurance. Self-employed workers can deduct health-insurance costs on line 29 of Schedule 1 of the 1040 form. That’s better than writing them off on Schedule A, where the deduction is curtailed.
People using health-savings accounts should make sure they’re set up by year-end. Then they have until April 15, 2020, to make 2019 contributions.
*Check eligibility for the new 199A tax break. The 2017 tax overhaul added a 20% deduction of net income that applies to self-employed workers, but limits kick in on taxable income of $160,700 for single filers and $321,400 for married couples filing jointly.
Self-employed workers whose incomes will exceed the limits may get below them by making tax-deductible donations to charity before year-end or contributing more to tax-deductible retirement plans.
*Be aware of retirement-plan deadlines. Freelancers can often make larger tax-deductible contributions to retirement plans than employees can. The 2019 contribution limits vary, from a maximum of $7,000 for a traditional IRA to more than $50,000 for SEP IRAs and Solo 401(k)s.
But pay attention to deadlines. Solo 401(k)s have a catch: For 2019, the contribution deadline can be as late as Oct. 15, 2020, but the plans usually must be set up by Dec. 31, 2019. Traditional IRAs for 2019 can be set up and funded until April 15, 2020. But the deadline to set up and fund a SEP IRA can be as late as Oct. 15, 2020.
Write to Laura Saunders at laura.saunders@wsj.com
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