If you participate in the sharing economy by working as a 1099 contractor or by renting your home on Airbnb, you likely need to pay taxes on your income. But just how much do you need to save in order to cover your estimated tax payments? This brief guide will help you effectively manage your Airbnb and 1099 taxes. If you’re an Airbnb host, you should also check out our specialized post on Airbnb estimated tax planning.
What is a 1099 Contractor?
Independent contractors don’t work on their clients’ payroll. Instead, they directly bill for their services, and their clients pay them in full with no taxes deducted. Businesses who hire contractors must report payments to contractors to the IRS using Form 1099 if the total exceeds $600 in a tax year. Contractors also get a copy of the 1099 so they can see what was reported to the IRS. Independent businesses and freelancers who work under this payment arrangement are commonly referred to as 1099 contractors.
Taxes for Independent Contractors and Freelancers
Most sharing economy workers are paid as 1099 contractors. They’re not on a traditional payroll, so there are no taxes deducted from their income. However, 1099 income still incurs self-employment taxes and income taxes.
Self-employment are the 1099 counterpart to payroll taxes. They include Medicare and Social Security taxes, and they add up to 15.3% of your net earnings.
You can calculate your total self-employment tax bill using the net earnings figure list on Schedule C in your Form 1040, tax return. Schedule C is also called “Profit or Loss from Business (Sole Proprietorship)”.
Why Are Self Employment Taxes Higher than Payroll Taxes?
A You may have noticed that the self-employment tax rate is double what W-2 employees pay. The self-employment rate is higher because it accounts for both the employer and employee portions of the tax. Normally, the employer & employee split this tax liability, but, since you’re employing yourself, you must cover the entire tax.
First, Airbnb hosts should determine if their rental income is taxable. If you rent your home for less than 15 days per year, your income is likely exempt from taxes. However, if you exceed that limit, you may have to make estimated tax payments on the income.
Airbnb Withholding
If you don’t provide a W9, Airbnb withholds 28% of your income [interlink to post] and applies it to your annual tax bill. In most cases, these withholdings are more than sufficient to cover any taxes on rental income. We recommend uploading a W9 to Airbnb so you can avoid withholdings altogether.
Does My Airbnb Income Incur Self-Employment Taxes?
Your business’s estimated tax status primarily depends on your involvement with the business & the services you provide to guests. If you provide “substantial services”, the IRS will treat you as a business and require you to make estimated payments.
Alternatively, your Airbnb income gets taxed as passive rental income if you don’t provide such services, so it doesn’t incur self-employment taxes. In this case, you don’t need to make quarterly payments for self-employment taxes.
IRS Substantial Services Criteria for Airbnb
According to the IRS, providing the following “substantial services” for your guests will reclassify your Airbnb as a Schedule C business. With this classification, you are responsible for paying self-employment taxes on net profit.
These substantial services risk classifying your Airbnb as a Schedule C business:
- Cleaning of the rental portion of property while occupied
- Concierge services
- Guest tours and outings
- Meals and entertainment
- Transportation
- Other hotel-like services
Insubstantial Services
Alternatively, the IRS will allow you to report your income via Schedule E if you only provide “insubstantial services.” Schedule E income is taxed as regular income, so it doesn’t incur self-employment taxes.
Here are some examples of insubstantial services you can provide to your renters and still remain under Schedule E.
Does Airbnb Require Estimated Payments for Income Taxes?
If you own your rental property, any income taxes incurred from Airbnb will likely be offset by the cost of depreciation on your home. Buildings require maintenance, and they tend to lose value as the become older. Depreciation accounts this cost by allowing you to claim partial deductions based on the value of the underlying asset every year.
Get a more detailed explanation of depreciation here.
Depreciation allows you to deduct a portion of your property’s “taxable basis” every year. Typically, a property’s taxable basis equals the purchase price minus the cost of land assets. Bare land doesn’t require maintenance and tends to retain its value over time, so taxpayers must exclude it from their depreciation calculations.
When you account for depreciation, your rental property is likely to recognize a tax loss at the end of the tax year, even if it’s produced a positive cash flow.
State and Local Taxes for Airbnb (SALT)
Depending on where you live, your income may incur additional taxes at the state and local level. Most states require income taxes, but depreciation deductions may negate them, as we mentioned under the federal tax section. You must also pay local property taxes for your rental, but payments are usually facilitated by your mortgage company via an escrow account, so they don’t require any action on your part in most cases.
In addition, some jurisdictions have recently enacted special taxes on short-term rental income. One example is Transient Occupancy Taxes (TOT), which Airbnb will automatically deduct and pay on your behalf.
In these cases, SALT obligations are facilitate automatically and require no action on your part. As such, there’s typically no need to put aside funds to cover these taxes. However, be aware of your obligations because they will impact your profit margins.
How to Calculate Estimated Tax Payments
The IRS and most state tax authorities require businesses to submit quarterly payments towards the taxes they incur throughout the year. Depending on your Airbnb business’s tax status, you may fall under this requirement. Estimated taxes can be intimidating, but they become a lot simpler when you understand how they work.
What is the Safe Harbor Rule?
The Safe Harbor Rule is an IRS policy that shields you from underpayment penalties if your payments meet a specific threshold. Often regarded as the simplest calculation method for estimated taxes, the Safe Harbor Rule uses your previous year’s tax totals to calculate your payment.
To qualify for a Safe Harbor exemption, you must pay at least 90% of the taxes due for the current year or 100% of your taxes from the prior year. So, if your taxes exceed what you paid last year, you can get away with matching your payments from the previous year without penalties or interest.
However, Safe Harbor isn’t a free ride, and it doesn’t excuse you from your tax obligations. If you underpay for the year, you will still have to pay the remaining balance by the mid-April filing deadline. Safe Harbor primarily benefits tax payers by giving them an easier way to calculate their payment and protecting them from penalties if their payments comprise a reasonable portion of their total obligation.
The IRS’s Safe Habor Rule calculation includes all tax payments, including withholding from a job or pension, along with any estimated tax payments for the year.
Safe Harbor Rule Tax Tips
If you expect to make less this year than you did last year, aim to pay 90% of your obligations for the current year. This strategy ensures you will pay the minimum amount necessary without incurring penalties.
Conversely, taxpayers who expect to outperform last year’s totals should aim to pay 100% of the previous year’s tax bill. You can calculate your quarterly payments by taking last year’s total tax and dividing it by four. This method will ensure you won’t be penalized for underpayment, but, keep in mind, you could end up with big tax bill at the end of the year due to your increased income.
How Much Should I Set Aside for Taxes as a 1099 Contractor?
You don’t want to come up short at tax time, so make sure you have enough money left over to cover your taxes. Many small business owners set aside 30% of their gross income to cover tax payments. Setting aside a percentage of your income in this fashion is a prudent move.
You can adjust the percentage as you see fit, but you should have enough to cover your taxes if you save 30%. This is more than enough for most taxpayers, so you could end up owing less than you saved. In this case, you can take the leftover balance and pretend it’s your own personal tax refund!
Where to Mail Quarterly Tax Payments
After you determine what you owe, you need to send your estimated tax payments to Uncle Sam. The first option is to mail a check or money order to the IRS.
You should also include any quarterly tax forms, like Form 1040-ES. The IRS mailing address changes depending on where you live, so follow the payment instructions on your tax form. You can find form 1040-ES here.
How Can I Pay Estimated Taxes Online?
You also pay your estimated taxes online through the IRS Direct Pay. The IRS receives your payment almost immediately when you pay online, so you don’t have to worry about your payment getting lost in the mail. You can even schedule withdrawals in advance, so you don’t have to rush to pay on the deadline.
The Direct Pay system provides a confirmation number for every payment, so you can provide evidence of your payment if you run into any problems. You can also look up your payment in the Direct Pay system. We recommend saving your tax payment confirmation emails in case you need this information down the road.
What Are the Quarterly Tax Deadlines?
You need to send in your estimated tax payments four times per year. If you don’t submit your payments before the quarterly deadline, the IRS could penalize you. These are the typical deadlines for quarterly estimated tax payments.
FIRST QUARTER DEADLINE: APRIL 15TH
April 15th is tax day, but it’s also the due date for first-quarter taxes. You need to pay income for income earned in January, February, and March by April 15th.
SECOND QUARTER DEADLINE: JUNE 15TH
Second-quarter taxes need to be paid by June 15th. Your payment should cover income from April and May.
THIRD QUARTER DEADLINE: SEPTEMBER 15TH
Estimated tax payments for income from June, July, and August are due on September 15th.
FOURTH QUARTER DEADLINE: JANUARY 15TH
This is the biggest payment of the year. It includes four months: September, October, November, and December.
Filing a Tax Extension
You can get extra time to file your tax forms with a tax extension. Most extension requests are automatically approved, and they give you an additional six months to file. Typically, the extended deadline falls on October 15th or the first business day thereafter.
But, even when you request a filing extension, you still need to pay your taxes on time. According to the IRS:
“An extension of time to file your return does not grant you any extension of time to pay your taxes. You should estimate and pay any owed taxes by your regular deadline to help avoid possible penalties. You must file your extension request no later than the regular due date of your return.”
IRS Policy
Click here to learn more about the easy way to file an automatic tax extension.
IRS Payment Plans
An extension gives you more time to file your 1040, but you still have to pay by the deadline. If you can’t pay by the deadline, initiate a payment plan with the IRS as soon as possible to avoid penalties. However, any outstanding balances will continue to accrue interest until they’re satisfied, even if you enroll in a payment plan.
Get Tax Help Now
Taxes are complicated, but you don’t have to go it alone. The tax pros at Shared Economy Tax specialize in taxes for 1099 contractors, freelancers, and other Sharing Economy participants. We have extensive expertise in this field that general CPA firms simply can’t match.
Our certified 1099 tax accountants are eager to answer your toughest tax questions, so schedule a chat with one of our experts today. Get started now with a no-obligation, one-on-one strategy session with one of our certified tax pros. Trust your taxes to the team that specializes in serving businesses like yours and chat with one of our tax experts today.
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