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.
As an independent contractor, you’re responsible for paying self-employment taxes. Plus, you also have to pay income tax. Unlike W-2 employees, you don’t have an employer withholding taxes from your paycheck. As a result, you’re probably going to owe the IRS money at the end of the year. However, the IRS doesn’t want to wait twelve months for its money, so they expect you to make quarterly estimated tax payments in advance. This might seem tricky at first, but you can easily calculate your estimated tax payments once you understand the process. Remember, every payment you make will go towards your taxes at the end of the year, so think of your quarterly tax payments as money down on your year-end tax bill.
1099 Contractors and Freelancers
Most sharing economy workers are 1099 contractors for tax purposes. These individuals are also interchangeably referred to as independent contractors or freelancers. The IRS taxes 1099 contractors as self-employed. And, if you made more than $400, you need to pay self-employment tax.
Self-employment taxes include Medicare and Social Security taxes, and they total 15.3% of the net profit on your earnings as a contractor (not your total taxable income). When you file your annual tax return, you will calculate this net profit on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). As a W-2 employee, your employer would pay half of this, and you would pay the other half. But, as an independent contractor, you must pay the entire amount.
Remember, self-employment taxes are assessed on net profit, not total taxable income. As such, you’ll need to calculate your net profit by subtracting deductions from your gross earnings.
Your income tax bracket determines how much you should save for income tax. For example, if you earn $15,000 from working as a 1099 contractor and you file as a single, non-married individual, you should expect to put aside 30-35% of your income for taxes. Putting aside money is important because you may need it to pay estimated taxes quarterly.
Your estimated tax payments will include both A) self-employment taxes, and B) income taxes.
Estimated Taxes for Airbnb Hosts
First, Airbnb hosts should determine if their rental income is taxable. The amount of taxes you owe depends on how many days you rent your place. Do you rent for less than 15 days per year? If so, you don’t have to pay any taxes on your rental income.
However, if you rent for 15 or more days per year, then you may need to put aside money for estimated tax payments. As a rule, Airbnb withholds 28% of your income for taxes if you do not provide them with a W-9 form. Although your effective tax rate will likely be lower than 28%, it helps ensure you have enough to cover taxes.
Whether or not you will need to make estimated self-employment tax payments on Airbnb income depends on the treatment of services you provide to guests. More precisely, if you provide “substantial services” to your guests, the IRS will treat you as a business, meaning you’ll need to pay self-employment taxes. Alternatively, if you do not provide these services, your Airbnb income will be treated as a normal rental property, meaning you won’t need to pay self-employment taxes.
Please review the below sections to determine the appropriate tax treatment for your Airbnb, or contact us to set up a Airbnb tax planning discussion.
Provide Substantial Services? Pay Self-Employment Tax
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.
- Cleaning of the rental portion of property while occupied
- Concierge services
- Guest tours and outings
- Meals and entertainment
- Other hotel-like services
Provide Insubstantial Services? Do Not Pay Self-Employment Tax
Alternatively, if you only provide the following “insubstantial services,” the IRS treats your Airbnb as a traditional rental property. This means that you report rental income on Schedule E (not Schedule C), and you do not need to pay self-employment taxes.
- Heating and A/C
- Water and Gas
- Internet and Wi-Fi
- Cleaning of common areas
- Trash collection
- Payment of HOA dues
Airbnb and Estimated Income Taxes
If you own the property used in your Airbnb business, you likely won’t owe any income taxes on this rental income. This is due to the incredible tax benefits of depreciation.
With depreciation, you can reduce your taxable income every year by a portion of your “taxable basis” in the property (typically the purchase price minus the portion allocated to land). As a result of depreciation, many rental properties recognize a taxable loss while being cash-flow positive in a given year.
Airbnb Income and State and Local Taxes
Additionally, you may also be liable for state and local taxes related to your rental income. If your jurisdiction requires that you pay Transient Occupancy Taxes (TOT), Airbnb will automatically deduct and remit the payment of TOT on your behalf. While you do not have to put aside more of your earnings to cover these taxes, you should just be aware that this money will be taken from your earnings upfront.
How to Calculate Estimated Tax Payments
The easiest way to calculate estimated taxes is to use the safe harbor rule. The safe harbor rule can protect you from IRS penalties for underpaying your taxes. Typically, underpaying your taxes can result in fines and interest. However, you can avoid penalties if you satisfy the requirements for the safe harbor rule.
What is the Safe Harbor Rule?
The Safe Harbor Rule is a guideline for federal estimated tax payments. By paying enough estimated taxes to meet the rule, you will not incur any penalties or interest on underpayment of estimated taxes.
To meet the Safe Harbor Rule, you must pay at least 90% of the taxes due for the current year or 100% of your taxes from the prior year.
The Safe Habor Rule calculation includes all tax payments, including withholding from a job or pension along with your estimated tax payments.
If you expect your current year’s earnings to decrease from the prior year, you should aim for 90% of your current year’s taxes; otherwise, you will overpay. If you’re unsure about your current year’s earnings, you should base your estimates on the prior year’s taxes because it may be difficult to determine your current year tax liability.
If you make $50,000 from freelance writing, you’ll owe approximately $10,000 in federal taxes (assuming you’re single, have no dependents, and use the standard deduction). In this case, you would want to pay 90% of your taxes by the end of the year, which is $9,000. These payments should be broken up into quarterly tax payments of $2,250 ($9,000/4). The remaining $1,000 could be paid with your tax return in April.
The following year, if your income increase, you would need to pay at least 100% of your prior year’s taxes ($10,000 in this case) to meet the Safe Harbor requirements. If your income decreased, you could reduce your payments to 90% of that year’s tax liability.
How to Calculate Estimated Tax Payments
It’s important to carefully and accurately calculate you tax payment requirements each year. Independent contracts should look at their year-to-date earnings and projected income for the remainder of the year to determine their estimate requirements.
If you send too much money, you’ll receive a refund at the end of the year. However, overpaying your estimates can lead to cash flow issues, especially for independent contractors.
If you underpay your estimates, the IRS will charge you penalties and interest on the underpayment amount.
The following steps will help you determine your estimated tax payment requirements.
Determine if your income will be greater than last year’s income. If so, use last year’s tax to calculate your estimated tax payments using either 100% or 110% based on your income and skip to Step #4.
If your income is lower than last year, look at your year-to-date earnings. Use this figure to project your total earnings for the year.
Calculate your projected tax liability. You may need to consult a tax professional to help you determine this step. Remember, as a freelancer, you need to include both your income taxes and self-employment taxes. Multiply this figure by 90%.
Make your payments according to the IRS due dates. The due dates for estimated tax payments are 4/15, 6/15, 9/15, and 1/15, although the exact dates can vary slightly because of weeks and holidays.
If you miss a payment, send it as soon as you can to minimize interest on the late payment. Don’t wait until you file your tax return to get caught up, or you could be on the hook for substantial late fees.
Local Tax Regulations
You must also account for local taxes. Depending on where you live, you may have to pay state, county, and city taxes, too. Consult with your local tax office to determine your local obligations. All in all, your total tax bill can equal as much as 40% of your income. That sounds high, but federal, state and local taxes can add up fast.
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!
Qualified Business Income (QBI) Deduction
Independent contractors should also recognize the potential tax savings provided by the qualified business income (QBI) deduction. The 2017 Tax Cuts and Jobs Act provided potential tax savings to contractors organized in any of the below ways:
- Sole proprietorship
- S corporations
- Limited liability companies (LLCs)
Specifically, this deduction allows these contractors to reduce their qualified business income by up to 20%. For example, say you have $20,000 in net profit – all QBI – as an independent contractor.
According to this new rule, you could deduct 20%, or $4,000, of that total, meaning you’d only pay income taxes on $16,000. Unfortunately, though, this deduction doesn’t reduce your self-employment taxes – just income taxes.
What is the Qualified Business Income (QBI) Deduction?
Many self-employed individuals are eligible to take a QBI deduction. Note that the deduction is limited for certain fields and at higher income levels.
The QBI deduction allows a 20% deduction for income from qualified businesses, however, there are several limitations on this deduction that we’ll explore below.
Who Qualifies for the QBI Deduction?
To qualify for the deduction, you must be self-employed or have income from a pass-through entity (such as an S-corporation or LLC). Certain businesses (called “specified service trade or business” or SSTB), are not eligible once their income reaches a certain level.
Phaseouts begin at the $170,500 mark for single taxpayers or $340,100 for married taxpayers filing jointly.
Examples of businesses that are considered SSTB include lawyers, accountants, medical practitioners, professional athletes, and performing artists.
Some examples of businesses that qualify for the deduction include restaurants, software firms, and retail businesses.
How to Calculate the QBI Deduction
Calculating the QBI deduction is complicated because it involves many factors. You’ll need to know your taxable income, your business type, and whether your business is an SSTB or not.
Assuming you have all this info, here’s a brief guide on the process for calculating a QBI deduction:
Determine your QBI
This is the net amount of income from your qualified trade or business (do not include all of your other income, such as investment earnings or W-2 wages).
Determine your taxable income
To find this number, calculate your total income minus deductions, including the standard deduction or itemized deductions.
Calculate your QBI deduction
If your taxable income is below the threshold (which changes each year), you can deduct 20% of your QBI. However, if your business is an SSTB, the deduction may be limited or phased out depending on your taxable income.
Apply any other limitations
The QBI deduction may be subject to additional limitations, such as the W-2 wage limitation and the UBIA (unadjusted basis immediately after acquisition) of qualified property limitation.
QBI Calculation Example
Let’s say you own a landscaping business that generates $100,000 in QBI. You file as a married couple and have a taxable income of $300,000.
Since your taxable income is below the threshold, you can deduct 20% of your $100,000 qualfied business income. In this scenario, your total QBI deduction comes to $20,000.
NOTE: QBI deduction calculations can be extremely complicated. But, the potential tax savings more than justify the efforts. Please contact us to help determine whether the QBI deduction applies to your situation.
To see how we estimate tax liability for 1099 contractors, watch our Webinar excerpt below.
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 read the instructions on IRS Form 1040-ES to find out where to send it.
You can find form 1040-ES here.
How to Pay Estimated Taxes Online?
You also pay your estimated taxes online through the IRS website. The IRS receives your payment almost immediately when you pay online. Plus, you don’t have to worry about your payment getting lost in the mail. The system provides a confirmation number for all payments so you have proof if you run into any problems. Best of all, you can easily make payments from the comfort of your own home. No stamps required!
To learn more about paying estimated taxes online, check out our detailed blog post on the topic.
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
Quarterly taxes don’t apply to everyone. However, if you owe, you need to pay or you’re risking consequences. Make sure you make all necessary payments before these pivotal deadlines.
If you don’t think you’re going to have your tax return ready by tax day, you can request a tax filing extension. An extension will buy you some extra time to file your taxes, but any payments will still be due on the regular deadline. If you can’t afford to pay, talk to the IRS about setting up a payment plan.
Most extension requests are automatically approved. If you extension is accepted, you’ll have until until October 15 to file, unless the date falls on a weekend or holiday. In that case, the deadline falls back to the next business day.
Click here to learn more about the easy way to file an automatic tax extension.
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.Â
- 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.Â
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.