With the advent of new companies such as Uber and Lyft, many people are taking the opportunity to earn extra income while retaining relative independence. If done right, this can be a lucrative endeavor. If done wrong, it quickly becomes an unexpected and expensive tax headache.
First, some fundamentals. Taxpayers are taxed on two levels. There is state and federal income tax (federal income tax ranges from 10% to 39.6% of earnings, depending upon income level). Second is payroll tax. Payroll tax consists of Social Security and Medicare, and is fixed at 15.3%. Employees pay one half (7.65%) and employers pay one half (7.65%). Self-employed individuals pay the entire 15.3%. Employees’ income and payroll tax are withheld from their regular paycheck and are taxed on gross earnings. Self-employed taxpayers pay their taxes on a quarterly basis and are taxed on net profit (gross, i.e., total business earnings minus expenses). As we will discuss below, this fundamental difference has a huge impact on your tax liability as a business owner.
For new Uber or Lyft drivers, here are some things to consider. You are not employees, but are Self-Employed Independent Contractors. Like it or not, you are now operating a small business. The IRS regulates businesses, large and small, in the same manner. As a business owner, you are required to pay quarterly taxes on net earnings, maintain records and file a Schedule C with your personal tax return.
If this comes as a surprise, you are in good company. A recent article in CNN http://money.cnn.com/2016/10/27/news/economy/gig-economy-workers/index.html points out that many Uber and Lyft drives do not have experience in business and taxes. As a result, they fail to take advantage of the available tax laws. The result is that at tax time, they are blindsided by a sizable tax bill.
Why? Congress gives business owners tax incentives for taking risks. In a nutshell, all expenses incurred in operating your business are deductible. These include expenses for operating and maintaining your vehicle, snacks or drinks provided to fares, cell phone charges, and in some cases home office expenses. These expenses reduce net profit and income and payroll tax. However, they must first be maintained in records and then claimed on your taxes. Failure to do so increases your taxable income, hence, the large tax bill. Remember, you only pay taxes on your net profit. So the goal is to reduce profits by claiming all of your business expenses.