Looking to pick up contract work while you’re looking for the next steady paycheck? Don’t forget a few significant differences in how that income is taxed.
By Kevin Fogarty
You’re between full-time gigs and looking to stay in the game — or maybe even considering freelance work as a longer-term employment option. What do you need to know to prepare for next year’s tax bill?
The big difference between a full-time job and freelance work is that you've become a 1099 instead of a W-2. Full-time employees receive a W-2 form from their employers listing their wages and deductions. Freelancers and consultants receive a 1099 form from their clients.
Consultant income tends to come in erratic spurts. Keep track of them and try to set aside 30 percent to 35 percent for your tax obligation; how much you will be obligated to pay will depend on how much you earn, deductions and other factors. It's painful to take away anything from an irregular paycheck, but it is less painful than trying to find the cash in April to pay the lump sum on an entire year’s tax obligation.
If you make less than $600 from one employer, they're not obligated to send you a 1099 at the end of the year, but you're still responsible for the taxes, so be sure to keep your own records.
Read the IRS’ self-employed page and its associated forms carefully. There are a lot of permutations to self-employment, many of which come with special requirements, benefits and unique forms to fill out.
For instance, there are special rates for farm work, fishing and work you do for religious organizations.
The trickiest part is the self-employment tax, which apparently flummoxed even Timothy Geithner, the former CEO of the Federal Reserve Bank of New York and current secretary of the treasury, when he was supposed to be paying it. Fortunately, the folks at TurboTax — the software Geithner said he was using at the time — have an explanation.
Basically, when you're employed, you and your employer split the payments for Social Security and Medicare. When you're self employed, you pay the full cost, which breaks down into 12.4 percent for Social Security and 2.9 percent for Medicare.
Simple? No. But you can deduct from your income-tax bill half of what you pay in self-employment tax.
And you're supposed to pay it quarterly, using the amount you made during the previous three months to estimate how much you'll make during the whole year.
Unemployment and job hunting
Unemployment benefits are taxable, by the way, but not all of them. The first $2,400 is all yours, though that's new for 2009. For the rest, you should have the unemployment office withhold about 10 percent.
Luckily, much of the money you're spending on job searching — for resume rewrites, career coaching and job-search services like TheLadders — are deductible. So are transportation costs, parking, tolls and other travel expenses directly related to your job search.
The bottom line? If you have income from several sources and have become a 1099 after a career as a W-2, and don't have any special background or skills in tax preparation, get as much good advice as you can on deductions and tax-saving strategies. Then get some professional help. In the end it will probably be worth it.
Don't forget to keep the receipts and any correspondence that would help prove the connection, in case anyone with an IRS business card wants to chat with you about them.