The gig economy can be a wonderful way to supplement your income while you’re building a new business. One of the benefits of Uber, Lyft, Shipt, Instacart, Doordash, Postmates or the host of other independent contract platforms is that you can decide if and when you work. As an entrepreneur balancing a demanding schedule, the ability to set your own hours and dial up or down the amount you work can be a godsend. However, the taxes that come with this supplemental income can be a major pain to deal with.
Although painful to think about, it’s well worth it to stay on top of what you owe. In addition to better understanding how much money you’re actually making, the difference between a freelancer who stays on top of his or her taxes and someone who doesn’t can be the difference of thousands of dollars a year.
Related: Managing Estimated Taxes: Gig Workers and Form 1099
How the IRS views freelancers
The first step to understanding your taxes as a freelancer is to see yourself from the government’s viewpoint. The IRS sees you as a mini corporation and, as far as they are concerned, you should be paying taxes just like a larger business does. This means you’ll be expected to pay tax on the profit of your business and have enough money saved up to pay the government when taxes are due.
When it’s time to pay your taxes as a freelancer, the revenue you’ve earned throughout the year is generally a cold hard fact — this is the total you’ve received from customers, or if you work with a labor platform (like Uber) you may be issued a 1099 MISC, 1099 K or other tax document. The government will likely have access to this information, so make sure your numbers match. However, what you claim for the expenses you incurred in earning that revenue is your responsibility.
For example, imagine two freelancers: Adam and Sarah. Adam and Sarah both earned $40,000 and spent $10,000 on gasoline and other business-related expenses. The take-home cash profit of both is the same at $30,000, however, Adam didn’t record very many of his expenses and files with a taxable income of $36,000, whereas Sarah kept meticulous records and files with a taxable income of $30,000. Sarah’s tax bill will likely be $1,000 plus lower than Adam’s.
Another important benefit of tracking your expenses and revenue is that you’ll see a real-time picture of how much money you’re actually earning. Most W2 jobs (hourly or salaried) come with very few out-of-pocket expenses. Driving a car as an Uber partner or building a business on Etsy will often have associated expenses that you’ll want to stay on top of in real time.
The process of recording expenses and paying taxes as a freelancer is already confusing, but made worse by the fact that the platforms intentionally avoid giving any tax advice in order to avoid approximating an employer-employee relationship (in other words, as an independent contractor, they cut you a check for the work you do and everything that comes after that is on you).
What can freelancers deduct?
What qualifies as a business-related expense? It depends on how you make a living. For example, a recording artist might keep records of the sound equipment they buy, while an Uber driver might claim mileage, cell phone accessories and their mobile phone plan.
If you’re an Uber driver, you might be wondering — doesn’t Uber track my miles for me? Actually, Uber and other rideshare platforms only track your miles when you have a passenger. If you’re only claiming these miles, you’ll likely be leaving a significant amount of money on the table as you won’t get credit for the miles you drive to pick up a passenger or go to the gas station.
Vehicle-related expenses: standard mileage method vs. actual
For many freelancers in the midst of launching a business, the majority of their expenses are vehicle-related. In that case, the IRS wants you to either add up every possible expense related to your car, which is referred to as the “Actual Expense” method, or claim a preset amount for each mile you drive as an expense. This is referred to as the “Standard Mileage Rate.” Actual Expenses include gasoline, maintenance, repairs, car washes, registration fees and the like. The Standard Mileage Rate is set each year by the IRS and is meant to be comprehensive of all car-related expenses. In 2018, the rate is $0.545 per mile, so if you drove 10,000 miles for your business that’s $5,450 worth of expenses you do not need to pay taxes on!
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Non-mileage expenses
As a solopreneur, there will be many other expenses outside of mileage that you’ll incur in your line of business (paint for an artist, nails for a handyman, etc.). The underlying premise the IRS will use to assess whether an expense is legitimate is whether it is deemed “Ordinary” and “Necessary” for your line of business. You can read more on their guidelines here.
In the example presented earlier of claiming a cell phone accessory as a business-related expense, a driver would likely justify the expense by saying it is both Ordinary and Necessary for her line of business (passengers expect an amenity like a cell phone charger and other drivers provide the same service). It would be much more challenging to justify purchasing an Xbox for passengers.
When in doubt
Searching online and talking to friends is a great place to start, but don’t be afraid to seek out professional services, as it pays to get advice from a trusted tax advisor who can review your specific circumstances. Many people are generous with their time and will speak to you for free if you’re serious about potentially becoming a client. This is a good time for me to say that I am not a professional tax advisor and the information presented here does not constitute professional advice.
If you can find a way to keep your revenue and expenses organized, you’ll make your tax advisor’s job much easier and have a significant leg up on understanding the true profitability of your business. Good luck and congratulations on setting out on your own!
