Frequently Asked Tax Questions
For Independent Contractors
For Tax Year 2004

Introduction : Soapbox : What Does It Mean to Be Self Employed? : What Does it Mean to Be an Independent Contractor? : What are some of the positives and negatives, tax-wise, of being an independent contractor? : What is depreciation? : As an independent contractor, what does the tax term "deductions" mean? : As an independent contractor, what can I deduct? : What other types of things can I deduct? : What kinds of things can an independent contractor NOT deduct? : Are there any particular tax programs I should be aware of?

* Introduction *

We here at TaxGrrrl.com believe firmly in putting the fun back in taxes. Yeah, I know that you are thinking, "She is out of her mind!" And I may well be. But please, bear with me a minute. Taxes are a game just like any other game. When you do not know the rules and are not playing well, games feel scary and decidedly unfun. But, when you learn the rules and are playing well seeing new ways to score points, etc, then it's a whole lot of fun! That is how we here at TaxGrrrl feel about taxes. We take the time to learn the rules (even though the IRS keeps changing them), we know how to play the game, and score all sorts of points. The result of this is not only that we can save you money but we can save you stress as well. And maybe, if we're all lucky, make it so you look forward to doing your taxes. (We do, so we know it's possible....)

That said, this FAQ section is dry and boring. We sincerely hope it does not put you to sleep, but felt that any other way of presenting this would be longer, harder to read, and more confusing.

While we tried to address the most common questions in this document, there may well be questions that are not here that you need answered. Please do not hesitate to email them to and we will add them here as well as email back an answer as soon as we can. Chances are very good that if you need something answered, someone else needs the answer too.

So without further ado...On to the FAQ:

What does it mean to be self-employed?

The term self-employed is a generic tax term that encompasses a number of different kinds of work arrangements. Put simply, it means working for yourself.

What does it mean to be an independent contractor?

An independent contractor is one kind of self-employed person. While s/he does work for other people, in general an independent contractor has more control over that work than an employee does. For example, an independent contractor decides where and when they do their work. They are also responsible for providing their own tools and equipment, and are not eligible to receive benefits (i.e. insurance or vacation time).

What are some of the positives and negatives, tax-wise, of being an independent contractor?

Positives:
• It qualifies you for various deductions as well as special saving options.
• It can reduce the cost of doing business (i.e. payroll costs, office space, office equipment)
• It gives you the option of turning a donation, which sometimes has limited tax benefits, into a business expense (advertising), which often has a greater tax benefit.
• You do not have money taken out of each check for taxes.

Negatives:
• If the work ends you do not receive unemployment.
• There is more to keep track of (i.e. receipts, mileage).
• The forms that need to be filled out at tax time can be more extensive or complicated and are more confusing for many.
• Many work related purchases need to be depreciated (see below).
• Since money is not taken out of every check, you must budget money for taxes.
• You are responsible for paying 15.3% self-employment tax. This breaks down into 12.4% social security tax [for the first $87,900 you earned in 2004] and 2.9% Medicare tax.
• After your first year of being an independent contractor you may have to pay estimated taxes four times a year (on April 15th, June 15th, September 15th, and January 15th) instead of only paying taxes once, in April.

What is depreciation?

If there is an item that is used for business that is expected to last for more than one year, you deduct only a portion of the item's cost during each year. There are guidelines that tell you the "usable life" of each type of item, and special rules exist that let you deduct a higher portion of the value in the first year than is typical.

As an independent contractor, what does the tax term "deductions" mean?

In this context, the term deduction refers to the monetary value of items used for business. Tax is figured on your income minus allowable deductions.

As an independent contractor, what can I deduct?

Many of the items an independent contractor can deduct have special rules. Here are some of the most common deductions with their rules.

Phone/Cell Service
You cannot deduct the cost of basic service on your first phone/cell, you can deduct the cost of any special feature(s) (i.e. three way calling) on the first line if you use that feature exclusively for business. If you have additional phone(s) or cell phone(s), you can deduct the business related percentage of their use (including basic service).

Work Clothing
You can deduct the cost of qualified work clothes. Qualified work clothes are clothes that you would generally not wear in public. For example, painter's clothes are not deductible, but airline pilot's uniforms are.

Office Space In My Home
If you have a qualified home office you can take deductions for it's use. A qualified home office is simply defined as a space in your home that is used only as an office. It should not have anything non work-related in it. This in particular includes couches, even though they are often found in non-home work environments. The office space should be used only and exclusively for work.

The deduction is calculated based on the percentage of square feet used or the percentage of rooms used as compared to the entire home. The percentages of utilities are calculated the same way and may also be deducted.

Health Insurance
Health insurance can be deducted for self-employed people as long as it is not provided by either their own employer (if they work both as an employee and an independent contractor), or a spouse's employer. Health insurance provided by employers can be deducted, under certain conditions, on a different section of the tax forms than that concerning business deductions.

Computers/Computer Equipment
You can deduct the percentage of your computer and computer equipment (i.e. hard drives, printers, modems) that you use for business purposes. Computers and computer equipment are items that need to be depreciated.

Desks/Chairs/office furniture
You can deduct the percentage of your desks, chairs, and office furniture (i.e. filing cabinets) that you use for business purposes. Desks/chairs/office furniture are items that need to be depreciated.

Internet Access
You can deduct the percentage of your Internet access that you use for business purposes.

Transportation
Self-employed people can generally deduct transportation costs.

What other types of things can I deduct?

Work related books, tools, props, classes, office space rental, office supplies, and protective equipment are some examples of things that can be deducted.

What kinds of things can an independent contractor NOT deduct?

Anything not directly related to your business cannot be deducted.

Are there any particular tax programs I should be aware of?

Many states offer a tax credit for people who rent their home/apartment. This credit can be worth thousands of dollars.

The Federal Saver Credit is something everyone should be aware of. This is a matching credit. The Federal Government matches up to 50% of every dollar (up to $2000) you put in certain kinds of saving accounts. The most common of which is the IRA (Individual Retirement Account) or Roth IRA. (Please see the TaxGrrrl Soapbox below)

There are several programs that help one control medical/health insurance costs. For self-employed people the HSA (health savings account) is worth looking into.

There are many other Federal tax credits available as well as several state specific programs. Many of these have to do with children. There are also credit programs available regarding home ownership.

* TaxGrrrl Soapbox *

Hey, while I've got you're attention....We here at TaxGrrrl want to help you out as much as possible, and not just with your taxes. One of the things that we feel strongly about is the benefits of saving money. It is best to start saving money as soon as possible. And now, at Tax Time, is a great time to think about starting that savings program, or adding to your nest egg. The federal government provides tax credits for money you save in certain types of accounts. The available programs allow you to put money away for retirement or disability, buying your first home, or paying for certain medical or education expenses. These programs vary. Some let you pay taxes later, some let you avoid paying taxes later, and some let you avoid it altogether. We are more than happy to explain these tax programs to you and suggest ways you can save for whatever rainy season you are waiting for or for the greener pastures ahead.

TaxGrrrl steps gracefully off her soapbox.

Thanks for listening.

Where can I go for more information?

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