Some Tax Basics For IT Consultants

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[[Independent Consulting - the setup]]

After I decided that I wanted to be a freelance IT consultant I needed to determine what [[LLC Vs S Corp|type of entity]] to setup.  Before doing that it's important to understand some tax basics that most career W-2 employees probably do not know.  As with all of these posts, I am neither a tax attorney nor accountant, please seek professional advice before attempting any of this on your own.  

Some Personal Tax Basics - Basic Formulas
Gross income - Above the line deductions = AGI (adjusted gross income)
AGI - Exemptions - Below the line deductions = taxable income

Above the line deductions are the most valuable since these are applicable regardless of whether you itemize deductions or not.  Below the line deductions are valuable only to the amount they exceed your standard deduction.  Above the line deductions for the self-employed include:

• IRA contributions
• 1/2 of your self-employment taxes (discussed below).  This assumes you are formed as an LLC.  For an S Corp this is different, and more lucrative.  

Determining if an expense is deductible as a business or personal expense is also important.  First, a business expense must be "ordinary and necessary" to your business, which leaves a lot up to interpretation.  It definitely does not need to be absolutely indispensible.  For the self-employed (organized as an LLC with pass-through taxing), business expenses are known as Schedule C deductions and they subtract from your income prior to calculating self-employment taxes. There are a variety of online tax tools available that can give a more accurate calculation.

FICA (Medicare and Social Security)
FICA is collectively Medicare and Social Security payroll taxes.  When you are an employee FICA is deducted automatically from your paycheck by your employer, about 7% is taken from your pay.  What you probably never noticed is that your employer matches that amount behind the scenes.  It won't show on your pay stub.  As a self employed person (LLC with pass--through taxation) you are now responsible for covering that employer match.  When a self employed person pays the total 15+% FICA it is known as "self-employment tax"  (SE tax).  That really sucks.