3 Tax Mistakes Independent Contractors Should Avoid

If you’re working as an employee of the company you’re contracted to, then your tax situation is pretty much straight forward. In fact, you may not have a lot of tax questions to answer. However, if you’re working as an independent contractor, then everything changes.

The number of self-employed persons in the U.S. has steadily grown over the past few years. In 2015, more than 7.4 percent of the country’s population was classified by the Department of Labor as Independent Contractors. Going by recent statistics, that’s over 10 million Americans.   If you add to this the number of people who depend on temporary or contract jobs, then the figure could be much bigger.

Initially, a report by Fox News showed that more companies are turning to temps, freelancers, contract workers, and consultants. The report suggests that the number could be around 17 million people equating to just over 12 percent of the population. That figure was projected to grow and could have reached over 20 percent of the population by the end of 2015.

If you’re and independent contractor, you should be aware of the serious financial and tax implications you potentially face. Bhatia & Co. Inc, CI has been working with hundreds of independent contractors from the wider Santa Clara, CA, region and has identified three costly mistakes that you need to avoid if you want to keep more of the money you earn.

Failing to secure a written agreement

This mistake is most common among newly hired independent contractors. Sometimes, out of excitement or because they don’t yet understand the importance, these independent contractors might fail to insist on a written agreement that specifies the terms and conditions of the contract. We advise that before you agree to any contract scheduled to last more than 30 days, you should sign a written contract that clearly states your status as an independent contractor and not an employee. More importantly, ensure that the contract is reviewed by a capable professional, preferably a lawyer.

Reviewing such a contract typically costs between $300-500. This could sound a bit much; but for new contractors taking their first contract position, it always proves to be money well spent because it ensures that you’re correctly classified by the IRS.

In one case in Texas, Cynthia, a middle-aged woman lost her job as a mid-level manager at a telecom company when the company was sold. Shortly, Cynthia was offered her job back, but on a temporary basis. She even managed to negotiate a higher salary than she previously earned. What she failed to realize was that the agreement signed defined her as a “qualified small business operated by a sole proprietor" rather than "a temporary worker." As you can guess, Cynthia soon found herself bearing a huge tax burden since she now had to pay state franchise taxes as a small business owner. Moreover, her new status made her liable for both the employer portion of Medicare and Social Security deductions!

Yet, it's something she would have easily avoided had she got a lawyer to review the agreement.

Failure to pay estimated taxes

According to the tax law, all independent contractors, freelancers, and self-employed individuals are required to pay estimated taxes four times a year. Employees are usually allowed to wait until April 15 to file their annual tax returns. That is also the time when an employee would be required to pay any monies owed. With contractors and other self employed persons, that is not the case.  If you’re an independent contractor, you have to file tax returns four times a year. The four dates for filing these returns are;

·      January 15,

·      April 15,

·      June 15, and

·      September 15

Several factors are considered before you can arrive at how much you need to pay for each quarter. These include filing status, standard deductions, tax credits, and itemized deductions among others. According to the IRS tax table for 2013, any independent contractor who files taxes singly would be required to pay $1,061 while a married couple filing jointly with an adjusted gross income of $10,000 would pay $1,003. Like most independent contractors have found out, involving a tax professional from the offset is the only way out.

1.    Failing to document deductible business expenses

If you’re to take advantage of all the business expenses that may reduce your taxes, you need to keep all records. This means you should clearly separate business from personal expenses. Sometimes it even becomes important to run a separate business account.

In general, a business cost qualifies to be deductible if the cost is incurred in connection with the trade, business or profession. There are also ordinary and necessary expenses as outlined by different tax authorities. And lastly, lavish or extravagant expenses are not deductible.  

Some of the rules, especially for state taxes, usually vary. For independent contractors living in Santa Clara, CA, consult Bhatia & Co, Inc, CI to learn about any new regulations that might affect you.

Learn How to Avoid These Mistakes and More from Bhatia & Co

Based out of Santa Clara, CA, Bhatia & Co, Inc, CI specializes in providing valuable tax solutions for both individual and small businesses/companies. Get help from a professional tax preparer. Call us today