Understand how expenses work on your taxes
Let me tell you right now: DO NOT, I repeat DO NOT ask for or listen to tax advice on Facebook or Reddit or any other forums.
I guarantee, you will be beseiged with bad advice.
What I cannot get over is how someone will ask a tax question in a forum, get a horrible answer, but take it as gospel.
One of the worst answers I see is “you cannot claim expenses unless you itemize your deductions.”
That one common mistake can cost you thousands of dollars in extra tax money. Please, Please find a tax expert. Do NOT follow that advice. Or any other that you receive, at least without confirming it with reputable sites or experts.
As an independent contractor, your business expenses are not recorded in your deductions.
I know, this part probably doesn’t make sense, but when you do your taxes you actually claim your expenses in the INCOME section of your taxes.
Okay, taxes are confusing sometimes, but there’s a method to the IRS’s madness.
Introducing Schedule C
You may have filed taxes before where you are used to entering your W2 wage information in the income section of your return. As an independent contractor (therefore as a business owner) you pay taxes on your profits, not on all of the money that comes in. The profit is your money coming in MINUS your expenses.
To help you report this, the IRS created a form called schedule C. The Schedule C is the self employed person’s version of a W2 – it’s how you as a business owner report what you made in your business.
I know, there’s a lot of stuff on the form, but the concept is actually pretty simple – what did you make, and what were your expenses? The whole idea of this form is to be a place where you enter both, and THEN you list the profit (money left over after deducting expenses from income) as income as you go back to filling your tax form.
If you were part time and had less than $5,000 in expenses, you may be able to use a simpler version called schedule C-EZ.
That’s a complicated form! Can it really save me thousands of dollars?
Absolutely. Abso-freaking-lutely. Especially if you are full time and you drive your car for deliveries. Here’s the deal: You pay 15.5% self employment tax on your profits ON TOP OF your income tax, which will start out at 10% of what’s left over after your deductions.
And with the IRS allowing 54.5 cents per mile for business expenses on this year’s taxes (and 58 cents for 2019) – that adds up VERY fast. I know of a lot of drivers who are driving more than a mile for every dollar they make. That’s a significant chunk of money.
Let’s look at a full time driver who earned $30,000 and drove 20,000 miles. We’ll call him Clyde. Clyde is single, this was his only income, he has no mortage so he takes a standard deduction. For the sake of illustration and simplicity, there are no other deductions or tax credits for Clyde or no other money he can add. Clyde believed the lie that he couldn’t claim his mileage because he does a standard deduction.
- Based on these numbers, Clyde owes $4,650 in self employment tax (word of warning to anyone who thinks this is high: your standard deduction or itemized deductions do NOT reduce self employment tax).
- For income taxes, Clyde’s taxable income is $18,000 ($30,000 minus his standard dedeuction of $12,000). He owes $1,970 in income tax.
- Overall, Clyde’s tax bill for the IRS is $6,620. That doesn’t even touch on state or local taxes – hopefully he has none because that was a HUGE chunk of his pay.
Okay, so fortunately someone gets Clyde’s attention and he files his schedule C now. Good thing he was tracking his miles. 20,000 miles equals $10,900 in expense claims on his taxes. That means his PROFIT is $19,100. Since Clyde is taxed on his PROFIT:
- Self employment tax is now $2,961
- Taxable income for income tax is $7,100 (19,100 minus 12,000), tax he owes for that is $710
- Total taxes = $3,671. That’s $2,949 less in taxes.
The Lesson Here?
Track. Every. Single. Mile. And every single expense. Learn what expenses you can track – think about it this way: You are getting paid for doing this.
Clyde tracked his miles, and the $10,900 worth of miles kept $2,949 in his pocket. Every dollar you spend that you record is going to save you at the very least 15 cents and possibly up to or more than 30 cents.
And you don’t have to itemize to save that money.