Do i need to charge sales tax for consulting services

When it comes to sales tax, the general rule of thumb has always been “products are taxable, while services are non-taxable.” 

Under that scenario, if your business sells coffee mugs, you should charge sales tax for those products. But if your business creates logos for coffee shops, you shouldn’t charge sales tax for those services. 

However, as with anything sales tax related, there are plenty of exceptions to this rule. Why? 

• Each of the forty-six US states with a sales tax makes their own rules and laws.
• States are expanding their tax bases, and for some states that includes requiring sales tax on services that were previously non-taxable.
• The digital world is blurring the line between products and services. Is an ebook a tangible product or is the ability to download it a service? How about software-as-a-service? Each state gets to decide.

What constitutes a “service” for sales tax purposes?

Let’s take a step back and make sure we know how a service is defined. The term services encompasses a wide variety of businesses. Services are roughly organized into these four categories:

• Business services – These include services for businesses such as advertising, computer services, human resources services, lobby and consulting and payroll services.
• Personal services – These include services such as dry cleaning, hair care, and tanning salons.
• Professional services – These include services provided by accountants, architects, attorneys, and doctors.
• Maintenance and repair services – These include services that are provided to tangible personal property (i.e. cars, your house) or improvements to buildings and land (i.e. landscaping)

Which states impose sales tax on services?

While services are not subject to sales tax in all states, It’s important to note that exclusions are not absolute. It all depends on the state. Here’s a quick breakdown of the general services sales tax landscape:

• Five U.S. states (New Hampshire, Oregon, Montana, Alaska, Delaware) don’t impose any general, statewide sales tax on goods and services.
• Four U.S. states (Hawaii, South Dakota, New Mexico, West Virginia) tax services by default, with exceptions only for services specifically exempted in the law.
• In the rest of the 41 states and the District of Columbia, services are not taxed by default, but services specified by the state may be taxed. 

Of course, if you do business in more than one state, that means that you need to understand how each state treats each of your particular products or services.

For example, in Hawaii, services are taxable unless specified otherwise. But in Texas, dry cleaning is taxable while veterinary services are not. Why? It’s simply because the state says so. 

How to Stay Compliant with Sales Tax When You Sell Services

It’s important for every business to perform a nexus study. A nexus study reviews all your business activities and sales in a state or multiple states and determines if these activities create sales tax nexus.

You’ll want to perform a nexus study when you start selling in a new state, or when you start selling a new product or service. 

For example, say you are a CPA in Arizona, where CPA services are not taxable. But you open up a second office in neighboring New Mexico. While Arizona doesn’t require CPAs to charge sales tax on their services, New Mexico does. This means registering with the state and ensuring you collect and remit New Mexico gross receipts tax (GRT, their equivalent of sales tax) at state-specified intervals. If you fail to collect from your New Mexico customers, you’re on the hook for paying New Mexico GRT out of your own profits.

Once you’ve conducted a nexus study, your next steps are: 

• Ensure you are registered for a sales tax permit in every state in which you are required to collect sales tax.
• Ensure that you charge the right sales tax rates. Establish rate tables and do your product taxability research, understand jurisdictional boundaries and where those rates apply, and keep up with any changes.
• File your returns. In the states where you’re registered, be sure to know your due dates, submit your returns and remit any payments necessary.  

How can I simplify sales tax compliance?

Need assistance determining whether or not your services are taxable? We recommend checking in with a vetted sales tax expert to help you conduct your nexus study and ensure that you are collecting sales tax correctly on the services that you sell. 

Now that you already know how to get into consulting, it's time to find out how taxes work for consultants.

In the U.S. alone, there are more than 42 million self-employed individuals. For many of those, dealing with taxes on consulting fees is a headache -- one that confuses and frustrates even the most number-savvy people, on par with the difficulty presented to some by contract templates or statement of work templates.

However, independent consultant or self employment taxes aren’t optional. While it can be tricky territory, learning how to calculate and pay self-employment taxes for your consulting work is a small price to pay to have the freedom of being your own boss.

In the growing gig economy, platforms like Bonsai are an excellent resource to help you manage your freelance consultant career.

In this article, we’ll explore taxes on consulting fees in more detail, giving you the insights you need to prepare for tax season.

Note: Try Bonsai tax to make your freelance consultant taxes a breeze. Our software will help you identify your tax deductions, estimate quarterly taxes, and stay on top of the filing deadlines. Users on average save $5,600 off of their tax bill. Don't leave money on the table. Claim your 14 day free trial here.

What is an independent consultant?

First and foremost, before you start filing 1099 tax returns, you need to figure out if the IRS actually classes you as a self-employed individual. 

If another business tells you what to do and how to do it, you may well be classed as an employee. In that case, the company you work for should take care of all your taxes.

According to IRS regulations,  you are generally considered self-employed if “you are a business owner or contractor who provides services to other businesses.” 

So, if that sounds like your situation, you need to learn more about taxes on consulting fees.

How are consultants taxed?

If you're working for a company, you're classed as an employee. As such, the company withholds your taxes and pays them for you. 

Once you confirm that you are indeed self-employed as an independent contractor or an employee, an obvious question arises:

How are consultants taxed?

The simple answer is that the onus is on you to manage your finances and to ensure you file your tax return. Before you get deterred by that idea, let's consider the significant tax advantages independent consultant have over employees:

• Independent consultant taxes can be offset by deducting business expenses.
• The relatively new TCJA law suspended "unreimbursed employee business expenses", listing them as miscellaneous itemized deductions.
• Independent consultants are eligible to get the 20% qualified business income (QBI) deduction, unlike employees.
• Independent consultants can get individual health insurance plans and retirement plans, whereas employees are on the company’s preferred plans.

Check out our full 1099 consultant tax guide.

Not bad, right?

But that’s not the full picture. Let’s discover more.

Did you know that you can use Bonsai for accounting? Or that Bonsai can help you calculate your 1099 taxes, help you manage them by providing tax estimates, filling date reminders, and identifying your consulting tax write-offs?

Let's see how that works. First, head to your main Bonsai dashboard and have a close look on the left side - we'll be working with the accounting and taxes sections. First click on "Accounting".

Inside the accounting section, you'll see a breakdown of your income and expenses. Both can either be automatically imported from your bank account, or manually added. Work you got paid for via Bonsai will also be registered here.

Make sure this section is properly filled in and click on "Taxes" next.

This is where the magic happens: Bonsai will do all the calculations for you, and we'll provide you with an overview of your tax estimates, a list of tax deductions you can use for the upcoming tax season, and reminders for all the upcoming filling dates.

Simple, right? If you're ready to check out Bonsai and explore all the features, go ahead and sign up for the free trial!

When to pay independent consultant taxes

Self-employed individuals must make quarterly payments to the IRS. These payments are due by the 15th of the month directly after the quarter’s end.

So, in 2021, your quarterly tax payments would be due on these dates:

• January 15th
• April 15th
• July 15th
• September 15th

If you are late, you could potentially pay the estimated tax penalty rate.

Note that even when you make these taxes on consulting fees each quarter, you still need to file your annual tax return by April 15th.

If you think you will owe taxes under $1,000, it’s easier to pay everything together in your tax return. However, if you earn more than this, the IRS will ask you detail the income for each quarter. As such, it’s better in the long-run to make the estimated quarterly payments.

Read on and learn about 6 tips for independent consulting taxes. With the basics in mind, here are a few pointers for managing independent consultant taxes.

Note: If you want automatic reminders sent to you about filing deadlines and an easy way to track your tax deductions, try Bonsai Tax. Claim your 14 day free trial here and see how much money you save. In fact, the average user saves approximately $5,600 from their tax bill.

1. File your tax return no matter how much (or little) you earn

Any income you make must be reported on your tax return. If you do consulting work for three or four companies, they will all report your earnings to the IRS. As such, you need to do your part. Also, if you lose your 1099 form, you'll still need to report your taxes.

If you earn less than $400, you won't owe the IRS any tax.  That being said, you should still file a return for the tax year, to stay on the safe side!

Remember: if you don't file a return, you can't claim any tax refunds.

Are you overwhelmed or confused by managing your business finances or preparing for tax season? Join Bonsai to make your consultancy more fun and let us help with expense tracking, identifying tax deductions, and estimating your quarterly taxes.

2. Understand what self-employment tax covers

Currently, the self-employment tax rate in the U.S. is 15.3% of your net earnings. This tax comprises:

• 12.4% for Social Security
• 2.9% for Medicare

Employees and employers share social security and Medicare taxes, splitting it 50/50, with the employer taking responsibility to ensure it is paid.

If you’re self-employed -- and above the $400 threshold -- the IRS will expect you to pay your own independent consultant taxes, which will cover your social security tax and Medicare.

3. Get smart about how you record all your self-employed business income 

For newcomers to self-employment, discerning your income is not always obvious. Independent consultants could generate income in multiple ways:

• Sales revenue when customers pay for your products or services
• Bonuses or commissions from referrals or sponsored sales
• Cash gifts from your clients for hitting targets

Knowing how to bill a client correctly is crucial, as that will help you track your sales revenue with greater accuracy.

Moreover, if you use the best tax and accounting software for self-employed consultants, you'll be in a better position to manage other income, such as gifts and bonuses.

4. Know which expenses are tax deductions

Once you become self-employed, you should get into the habit of tracking your freelance expenses, as these can be listed as business deductions to reduce your taxable income (you can track these deductions by using a business expense spreadsheet).

Some common expenses you can list as deductible include:

• Advertising and marketing – Business cards, website hosting, social media ads.
• Home office – Laptops, printers, even a portion of the electric and internet bills may be deductible.
• Vehicle expenses – Travel costs between clients. You can even keep track of mileage for taxes.
• Startup costs – Training programs, starter kits, etc.
• Sample inventory – Demo products can be deducted unless you sell them. In this case, they would be inventory.

With all items that you intend to list as business expenses, you should keep the receipts for taxes to prove the purchase cost.

If you are a legal consultant, check out our list of common tax deductions for attorneys.

Independent consultants don’t need to waste their time when tax season comes. Let Bonsai help you save on taxes and get peace of mind - sign up for your free trial today.

5. Separate your business activities from hobbies  

It's quite common for people to become an independent consultant to get a decent discount on a product they like. Much to their surprise, that can lead to a profitable side-hustle, which can soon turn into a full-time business.

As mentioned before, you need to report any income to the IRS, so it's essential that you determine the profitability of your consultant work -- or any other side gig for that matter. Here's our breakdown of a hobby versus business.

6. Be aware of travel

Visor report that consultants who travel a lot may need to file taxes in multiple states. This could come as a shock to some consultants to find out that each state government can claim some of their income if it was earned in that state.

Make sure you don't pay double state tax in this instance, as you may be entitled to a tax credit in your home state if you pay taxes in other states.

Taxes on consulting fees don’t have to be hard

Naturally, it takes a little time to get acquainted with managing your own taxes and filing returns. With these tips, you can be prepared for tax season ahead of time, keeping up-to-date with quarterly payments, expense tracking, your income, and submitting your return on time (to avoid any filing penalties).

If you need some extra assistance in managing your self-employed business and finances, join Bonsai to use the range of specialist tools that make business management much easier for independent consultants and freelance business owners.

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