In today’s gig economy, working as an independent consultant is hugely popular – but the additional income means there are tax implications to think about. Independent consultants work for single and multi-level marketing companies, but they are not considered employees. They sell a product directly to customers through personal connections and hosted events like in-home parties. They can also recruit other consultants and earn a bonus or percentage for sales that happen down the line.
The IRS calls independent consultants “direct sellers,” and they have rules for how you should file your taxes. If you’re worried that your new gig makes you more likely to be audited, follow these tips and feel confident when tax season rolls around.
1. File your tax return
Anytime you earn income, you generally need to report it to the IRS on your tax return. The company you represent is reporting your earnings on their end. The IRS will know what you made even if you don’t file a return. But just because you do file a return doesn’t mean you’ll have to pay taxes. If your net business income, or your revenue minus your expenses, is less than $400, you won’t owe any tax.
Let’s say you only earn $150 selling ItWorks! If you have other income to report on your tax return, you should claim this $150. If you do not have other income, you aren’t required to file a tax return since your total earnings for the year were less than $400. However, you can‘t get a tax refund if you don’t file a return.
2. Report all your business income
When you are an independent consultant, you may receive different types of income:
- Income from sales when customers buy your products
- Commissions, bonuses, or percentages when someone you sponsor made a sale
- Prizes and awards
- Products you receive for meeting a sales quota (earn all the products on the front page of the spread when you sell so much product that month)
- Other gifts offered by the company to you (not hostess gifts)
Most companies will send a Form 1099-Misc (Non-Employee Compensation) to independent distributors who earned over $600 or purchased more than $5000 in inventory in the previous year. This is the form you will use to complete your tax return. It should account for all your income types.
3. Pay self-employment tax
Since you are not an employee for your company, they do not withhold money from your pay for Social Security, Medicare or income tax. As an independent consultant you are considered self-employed, so if you earn more than $400 for the year, the IRS expects you to pay your own tax.
The self-employment tax rate is 15.3% of your net earnings. It consists of the following:
- 12.4% for Social Security.
- 2.9% for Medicare.
If will owe $1,000 or more in taxes when you file your tax return, then you should pay estimated tax throughout the year. If you expect to owe less than $1,000 in taxes, you can pay it all at once when you file your tax return. (Read more about quarterly estimated taxes for the self-employed.)
4. Know which expenses you can deduct
Business deductions are a way to lower your taxable income. This can reduce both your regular income tax and your self-employment tax. Direct sellers can generally deduct ordinary and necessary business expenses, including:
- Advertising and marketing – Deduct the cost of business cards, fliers, even a nifty decal on your car.
- Home office – If your space is exclusively used for business, you can deduct $5 per square foot using the simplified method.
- Business miles and vehicle expenses – The miles you drive delivering product from one customer to another are deductible. Careful, though. You can’t deduct personal travel (even if you have a nifty decal on your car).
- Startup costs – Starter kits, training, and any fees you pay to become a consultant are deductible up to $5,000. You can choose to deduct or amortize these.
- Sample inventory – Products that you use for demonstration are deductible. If you sell the samples instead of using them entirely for demonstration, they should be counted as inventory.
Reminder: Inventory that you sell cannot be used as a tax deduction. The value of your inventory will be used to decrease your income before calculating taxes.
5. Separate business activity from hobbies
Maybe you became an independent consultant to get a good price on the product, but you had no intention of turning it into an actual business. If you’re not really in direct sales for the money, you will still need to report any income you do earn – but you won’t be able to deduct your expenses. Find out if the IRS considers you a hobbyist or self-employed.
This article is up to date and accounts for tax law changes for tax year 2018 (tax returns filed in 2019). Learn more about tax reform enacted under the Tax Cuts and Jobs Act here.