What You Need to Know

If you have a job where you get paid directly by clients or customers, instead of receiving a W-2 from an employer, you're considered self-employed for tax purposes. This includes freelancers, gig workers, and anyone with a side hustle. Self-employment comes with its own set of tax responsibilities, but it also offers some unique opportunities.

Self-employed individuals are responsible for paying both income tax and self-employment (SE) tax, which covers Social Security and Medicare contributions. Unlike W-2 employees, who have these taxes withheld from their paychecks, self-employed individuals need to account for these costs themselves. It's important to set aside enough to cover these taxes, especially if you’re making estimated quarterly tax payments.

The upside? There are some valuable tax breaks available to self-employed individuals. You may be eligible to deduct expenses related to your business, like office supplies, travel, advertising, and even a portion of your home if you use it as a dedicated workspace (home office deduction). Keeping detailed records of your expenses is key to maximizing these deductions and reducing your taxable income.

To avoid surprises, make sure you're keeping up with estimated tax payments throughout the year. These payments help you stay current with your tax obligations and avoid underpayment penalties. If you're unsure about what you owe or which deductions apply to you, consulting with a tax professional can help make sure you’re getting it right and taking advantage of all the benefits available to you.

Legitimate Businesses have a Profit Motive

While the government understands that businesses may occasionally incur losses, legitimate businesses are expected to have a profit motive. If your business consistently reports losses year after year or if your expenses significantly offset most of your income, the IRS may consider it a hobby rather than a business. This distinction is important because hobby expenses are not deductible in the same way that business expenses are. A repeated pattern of losses or significant expenses can increase the likelihood of an audit, so it's crucial to maintain clear records and demonstrate a genuine intent to make a profit.

Who Receives Form 1099-NEC or 1099-MISC?

Form 1099-NEC is used to report payments made to you for services you performed as an independent contractor rather than as an employee. This form is typically issued to freelancers, gig workers, and anyone who is self-employed and received compensation of $600 or more from a client during the tax year. It’s important to understand that income reported on Form 1099-NEC is subject not only to regular income tax but also to self-employment tax, which helps cover Social Security and Medicare contributions.

Form 1099-MISC, on the other hand, is used to report other types of payments that aren’t for services performed as an independent contractor. This may include income like rent, royalties, lawsuit proceeds, awards, or prizes. Unlike wages from a traditional job, these types of income are often taxable, and it’s crucial to report them accurately on your tax return to avoid any issues with the IRS.

Both forms represent income that must be included in your tax return, and keeping detailed records of all income sources will help ensure that you’re filing correctly. Misreporting income can lead to penalties or even audits, so it's always best to stay organized and proactive. If you have questions about these forms or how to handle the associated income, consulting with a tax professional can provide the guidance you need to stay compliant.