The Tax Bill Nobody Warned You About

By Frank Gramlich, CPA | Xavier Financial Services

September 15th is a tax deadline. If you've been self-employed for a few years, you know this. If you became a 1099 contractor sometime in the last twelve months, there's a reasonable chance nobody mentioned it to you at all.

That's the situation a lot of newly independent contractors find themselves in right now. Professional service businesses have been shifting toward contractor arrangements at an accelerating pace, and for many workers, the transition happens before they've had a chance to fully understand what changes on the tax side.

Here's what changes: as a W-2 employee, you and your employer each paid half of Social Security and Medicare tax. As an independent contractor, you are responsible for both halves yourself. That's the self-employment tax, an additional 15.3 percent on your net income as a sole proprietor or 1099 contractor, and that is in addition to your regular income tax. If your gross pay stayed the same and you haven't adjusted your planning, your tax picture looks meaningfully different this year than it did last year.

This doesn't always get explained as clearly as it should before the transition happens. Most newly independent contractors piece it together over time. Over time means sometimes at an information session, but many times not until your first 1040 federal tax filing date arrives.

The good news is that this situation is very manageable if you take it seriously now. September is a good time to do that, because you have options which still have time to work before December 31.

The first is making sure your quarterly payments are on track. If you've been guessing, or skipping them, the IRS will assess a penalty regardless of what you owe at filing. Getting current through Q3 stops the bleeding.

The second is looking at your business structure. A single-member LLC doesn't reduce your self-employment tax by itself. By default, a single-member LLC is taxed the same as a sole proprietorship. An S-Corp election changes that picture, because it splits your income between salary and distributions. We talked about the timing of that election last month. The consequence of not making it is exactly what you're asked to consider right now.

The third is understanding what you can actually deduct. Home office, equipment, software, professional development, phone, and mileage are all deductible business expenses which reduce the income your self-employment tax is calculated on. Most newly converted contractors are leaving money on the table because they've never had to track this before.

If you've made the move to independent contracting (whether by choice or by circumstance) I'd encourage you to lean into it. Set up the LLC but understand your tax picture. Start thinking of yourself as a business owner, because that's what you are now. The contractors who come out ahead at tax time are the ones who took this seriously from the start, and September is still early enough to do that.

Speaking of September… welcome back football! Stick & puck isn't far behind, and Red October is sure to follow!