The reason you’ll receive an IRS Form 1099 is if you earned income as an independent contractor, sole proprietor, sole owner of an LLC, or a self-employed person.
As a sole proprietor, you work for yourself, while small business owners who run LLCs, partnerships, or corporations may hire employees, independent contractors, or both.
As a self-employed individual, there are certain filing requirements when it comes to tax time. You must pay self-employment tax (SE tax) as well as federal income tax and state tax (if applicable). SE tax is a Social Security and Medicare tax for individuals who work for themselves. If you work for an employer, your company pays half the Social Security and Medicare taxes (7.65%) and you pay the other 7.65%, which your company will withhold from your paycheck.
However, because you do not work for an employer, you are responsible for the total tax amount. As a self-employed individual, you pay the full 15.3% tax, and deduct 7.65% of that tax as a business expense.
If you’re self-employed, you’re responsible for tracking your own income instead of having your income tracked through an employer’s payroll software. As a result, you could make unintentional errors on your taxes.
If you want to keep more of your hard-earned money, take a close look at these seven common mistakes that many individuals make on 1099s, plus four tax tips to help you avoid an audit.
1. Misunderstanding Form 1099
There are a number of different 1099s, and each has specific tax-reporting requirements. You might receive Form 1099-R for distributions from pensions, annuities, retirement, profit-sharing plans, IRAs, insurance contracts, etc. Or you might receive Form 1099-S if you received sales proceeds from a real estate transaction.
If you’re self-employed (full-time or part-time) and earned an income but you don’t receive a paper form, maybe because it was lost in the mail or your address is listed incorrectly, you still have to self-report the income on your taxes. Not reporting the income may trigger an audit, which could result in paying back taxes, plus interest and penalties.
If you earned $400 or more from self-employment, you have to file an income tax return. If you earned less than $400, you might still have to file an income tax return if you made more income from another source.
With the added flexibility of contract work comes added responsibility. If you are a newcomer to the world of contract work, make sure you educate yourself on Form 1099.
1040 vs. 1099
There’s often some confusion with forms 1040 and 1099. Here’s the simplest explanation.
Form 1040 is the individual income tax form that’s used for employees and independent contractors alike. You’re required to complete and submit a 1040 every year by the tax deadline.
Form 1099, on the other hand, refers to the form you’ll receive if you’ve been paid as a self-employed individual (contract-to-hire, independent contractor, consultant, etc.). You should receive a 1099 from any client who paid you $600 or more for your work during the tax year.
Even if you didn’t make over $600 in self-employment income and didn’t receive a 1099, you should still report your self-employment income. Businesses are required to send out Forms 1099 on or before Jan. 31 of each year for the prior calendar year.
But if you expect to receive a 1099 and don’t receive it by February 15, the Internal Revenue Service recommends you contact them. You might be able to use a substitute form to file your return or file your taxes online.
2. Not writing off all business expenses
One of the perks to being a self-employed contractor is a bit more leniency in what qualifies as a business expense.
For example, a company might pay an independent contractor or an employee for similar work, but as an employee, you typically don’t get to write off your commuting costs. On the other hand, if you’re self-employed and you primarily work from your home office, whenever you spend time driving to and from a client’s office you can write off the mileage as a business expense.
You can take the business portion of your actual car expenses — like gas, insurance, registration, repairs, and maintenance — or any public transit expenses if you use local transportation.
You can also depreciate most business equipment that has a useful life of more than one year and that you actually use in your business for more than one year. This may include computers, furniture, and machinery. You can take a depreciation expense using Form 4562.
As a self-employed contractor, taking all of your business expenses is the easiest way to keep more of your hard earned cash. Not doing so means you’re overpaying hundreds or even thousands of dollars in taxes each year.
3. Writing off personal expenses
It’s generally understood that you can’t deduct expenses that are clearly personal. That said, what are considered personal expenses and business expenses isn’t always clear.
For example, if you use your cellphone for both personal and business use, you can’t write off the entire cell phone bill. Instead, you need to prove predominant business use — meaning your cell phone must be used more than 50% of the time for business purposes.
Your computer and vehicle fall under the same constraints, meaning you can only deduct the portion that is used exclusively for business. In other words, think twice before writing off the entire cost of your computer unless it’s used solely for work.
Writing off partial-personal expenses will require some leg work and good record keeping on your part so you don’t raise any red flags with the IRS. Only take a deduction on your taxes for the portion of personal items that are used exclusively for your business. The IRS allows you some wiggle room here, so just make sure you have a compelling reason for writing off 80% of that cell phone bill.
4. Writing off mileage and car expenses
If you’re self-employed, there may be times when you have to use your car for business. Mileage is probably the biggest deduction, but a percentage of the wear and tear on your vehicle from business use can also be deducted in one of two ways.
- The actual vehicle expenses method: Start by adding up all of your vehicle operating expenses, such as interest on your loan (or cost to lease a vehicle), insurance, gas, repairs, maintenance, etc. Next, divide any miles you drive solely for business by the total miles driven. That percentage becomes your allowable deduction.
- The simplified method: Apply the current IRS-mandated mileage rate to the total miles driven for business in the year. For tax year 2019, the standard mileage deduction is 58 cents per mile for business use, up from 54.5 cents in 2018.
Whichever method you choose, you must keep track of all mileage used for business in a vehicle log. This can be as easy as jotting down miles, dates, and descriptions in a notebook, or you can use software like QuickBooks Self-Employed to keep track of your mileage and avoid any errors.
5. Not keeping adequate or accurate records
Even if you’ve done a great job deducting all of your allowable business expenses on your taxes, it will all be for nothing if you haven’t kept adequate records. The IRS requires you to keep track of all business receipts as proof that you actually incurred each of the expenses. Yes, it takes a little time and organization on your part, but it’s worth the effort in the long run.
When it comes to 1099 income, one of the main reasons mistakes are made is a lack of organization, and those mistakes can lead to additional tax payments and penalty fees.
6. Paying quarterly taxes
For the self-employed, federal income taxes are generally paid on a quarterly basis by a specified due date. If you’re not having taxes withheld by an employer, the burden is on you to pay estimated taxes four times a year at the end of each fiscal quarter. The due dates are April 15, June 17, September 16, and January 15 of the following year.
In general, if you expect to owe less than $1,000 in taxes for the year after subtracting federal income tax, you are exempt from quarterly tax payments. Also, if you have federal tax withholdings — perhaps because you also have W-2 income or because one of the companies you contract with takes withholdings — you may be exempt from filing quarterly taxes as long as those federal tax withholdings equal 90% or more of what you’ll owe for the year.
However, you are responsible for making quarterly payments if you expect to owe tax of $1,000 or more when you file your return.
7. Penalties for late or non-payment
No one likes to pay taxes. Even so, the IRS can penalize you if you don’t file quarterly taxes. The penalty for non-payment can be as much as 5% for every month the payment is late, but it cannot exceed 25% of the total payment due.
If payments are more than 60 days late, the IRS will assess a $100 penalty. Penalties can also be applied for underpayment of estimated taxes. Fortunately, QuickBooks Self-Employed can manage your deductions and calculate quarterly tax payments.
4 tips to avoid an audit
Mistakes can lead to steep fines and possibly an IRS audit. And even if you try to avoid common mistakes, you could still trigger an audit.
The truth is, the IRS uses your taxpayer identification number and mathematical formulas to select individuals from all groups, which means that everyone has a chance of being selected for an audit. It’s the IRS’s way of keeping people honest.
Think of it this way: If the IRS only looked at people who made more than $5,000 in net earnings, then some taxpayers might change their books to look like they made less than $5,000. So everyone qualifies for an audit regardless of their earnings. That being said, there are a few steps you can take to lessen your chances of an audit.
Here are four tips to keep your taxes on the up-and-up and keep the IRS off your back.
1. Ensure your reported income matches your tax documents
As an employee, you receive a Form W-2 at the end of the year, but as a contractor, you receive a 1099-MISC form. Both forms summarize income you’ve earned, and copies are sent to the IRS so they also know how much you made during the year. Since these forms are tied to your Social Security number, their system will automatically pick up any inconsistencies, which will increase your risk of an audit.
So, if the form you receive doesn’t match the amount you were paid out, take these steps:
- Make sure you haven’t made a mistake. For example, a 1099-K might include commissions and fees in your gross payout. You can deduct these as a business expense, so your taxable income and tax brackets aren’t affected by the fees.
- Contact the company who hired you as a self-employed contractor to request a reissue. Make sure they are paying you non-employee compensation. Sometimes company’s make mistakes on your 1099, so it’s best to contact the company as soon as possible to sort out the issue.
2. Carefully document any commonly audited expenses
The IRS will audit some income and expenses more than others — either because people commonly abuse the system or commonly make mistakes. For self-employed contractors, a few common areas that sound the alarm are:
- Car expenses: Make sure all mileage you deduct is for business purposes only and has been properly logged in a logbook or via a mileage tracker.
- Home office expenses: The portion of your home you specify as a home office must be your primary place of business and used regularly and exclusively for work. The home office expense deduction is closely reviewed by the IRS.
- Meal expenses: Make sure the meals were either with a client and had a business purpose, or were incurred while traveling overnight on a business trip.
3. Don’t claim that a hobby is actually a business
If you sustain a business loss for three out of five consecutive years, the IRS might call you up, claiming that you’re pursuing a hobby and not actually running a business. You’ll need to prove that you actually had the intent to make a profit and clarify the reasons why you didn’t.
If the IRS decides your business is actually a hobby, they might disallow any business expenses you have previously written off, meaning you could be on the hook for back taxes and penalties.
4. Don’t call attention to your income
The IRS commonly compares your income to others in similar situations. If you only claim $5,000 in income but live in a wealthy zip code or if you made a lot of money last year and no money this year, that will also increase your likelihood of an audit.
Taking everything into account
Use these seven tips to understand the ins-and-outs of a 1099. And to make sure you’re ready come tax time, keep your expenses and receipts organized so you can claim the maximum amount of deductions you’re eligible for as a self-employed worker.
In addition, pay your quarterly taxes correctly and on-time, and steer clear of common tax mistakes to avoid being audited unnecessarily.
In the event that you are audited, you’ll be better prepared to help make it a smooth process for everyone.
For more tax-season tips, see our guides to taxes for the self-employed and filing taxes when you have both 1099 and W-2 income.