Understanding taxes can be a learning curve for independent insurance agents, especially in the face of a growing book of business and employee roster.
As part of our series on becoming an independent insurance agent, we take a look at standard tax obligations for small businesses, along with some possibly surprising tax breaks you may be able to take advantage of.
Tax Expenses for Agents
Generally speaking, independent agents are classified as independent contractors when reporting taxes. Under this type of arrangement, the government considers you as self-employed, meaning you’re responsible for reporting your own taxes.
When someone is employed by a company, they receive a W-2, and the employer withholds a certain amount of money for them, says Curt Mastio, a CPA who runs Founder’s CPA, an accounting service for startups. When you’re self-employed, you are required to report your income to the IRS through a 1099 form.
“Every person or business that pays an independent contractor above $600 for work is required to file Form 1099 with the IRS; both the IRS and the independent contractor receive a copy of the 1099,” according to online legal advice resource LawFirms.com. “Independent contractors should receive a Form 1099-MISC from each of their clients that pay them $600 or above during a tax year.”
Quarterly Estimated Tax Payments
Personal finance writer Ben Luthi says you’ll usually want to make quarterly estimated tax payments, which are due on April 15, June 15, September 15 and January 15 (for the prior year’s final quarter). There are two main reasons why.
First, it prevents you from having to pay the money in one lump sum when you file your annual tax return, which can often be a financial hardship for fledgling agents. Second, it ensures that you don’t get fined by the IRS for underpayment of taxes, notes the team at TaxSlayer, a tax preparation company — something you’ll get hit with if you owe more than $1,000 to the IRS.
To calculate how much you’ll need to pay each quarter, online bookkeeping services company Bench Accounting has a helpful calculator to streamline the process.
Note that most states have income taxes, which you’re also responsible for paying as an independent contractor, says business writer Jean Murray, Ph.D. This will vary by state, so it’s important to know what the specific tax rate is in your state.
Katherine Loughead, senior policy analyst with the Center for State Tax Policy at the Tax Foundation, created a detailed guide that explains everything you need to know about individual income taxes, and wage and salary income taxes, plus notes key changes in tax codes.
How to Handle Taxes as an Employer
Up to this point, we’ve discussed how to handle taxes when you work for yourself. But let’s say you just hired someone full-time as an employee. What’s your responsibility then?
First of all, you can still be classified as a sole proprietor and not treated as an employee of your business — this means, you will pay self-employment taxes for yourself.
However, there’s no limit to the number of employees you can have as a sole proprietor, writes Kaylee DeWitt at Patriot, an accounting and payroll software provider. As an employer, you must take care of employee administration, recordkeeping and the taxes for each employee you hire. In other words, you have the same responsibilities as any other type of employer.
Before hiring anyone, says DeWitt, you first have to obtain an employer identification number from the IRS. During onboarding, each employee is required to complete various forms including a W-4, which is an employee’s withholding certificate, and Form I-9, which is an employment eligibility verification. If you plan on offering benefits, you may need to have them fill out additional forms for that as well. You can find more information on employee benefits here.
Once an employee begins working for you, legal writer Jeffry Olson, J.D. notes that it’s your responsibility to “withhold all required employment taxes from the worker's wages and contribute appropriate employer taxes.” As of the 2019 tax year, this was 6.2 percent for Social Security and 1.45 percent for Medicare. For full details, consult this resource from the IRS.
At the end of each year, you must provide a Form W-2 — known as a Wage and Tax Statement — to each of your employees. This is how you report how much they earned to the IRS.
Tax Deductions You May Not Be Aware Of
Although you could make the point that reporting taxes comes with more headaches for independent agents than many other careers, there are also some significant benefits. One of the inherent perks of being an independent agent is there are numerous tax deductions you can make, helping reduce how much you owe, according to insurance marketing organization Symmetry Financial Group.
Here are some of the tax breaks you may not be aware of.
“The IRS allows you to deduct reasonable advertising expenses that are directly related to your business activities,” explains licensed CPA Aaron Lesher, head of strategic initiatives at expense-tracking app Hurdlr. “The deduction for advertising expenses is broad and can include a number of expenses depending on what industry you work in.”
Business cards, hosting for your website and digital advertising are just a few examples of common marketing costs that are tax deductible. Even T-shirts with your agency’s logo that are used for advertising count, says Jen Stafford, cofounder and partner of CTRL+ALT Digital, a full-service digital agency.
It’s common for independent agents to travel frequently to meet with customers outside the office, attend conferences and local events. Whenever you use your vehicle to drive to these locations, the related expenses are tax deductible, writes financial journalist Amy Fontinelle.
That’s why you should always keep accurate records of the date and purpose of each trip, and more importantly, how many miles you drove. As of 2019, the standard mileage rate was 58 cents per mile, meaning you can deduct 58 cents for every mile you drove.
Just be sure that you only claim business car trips and not personal ones. For more information on this topic, Julia Kagan, personal finance editor at Investopedia, created a helpful guide regarding standard mileage rate.
Business-Related Meal Costs
According to legal writer Stephen Fishman, J.D., the IRS also allows you to deduct 50 percent of meal and beverage costs. This can’t be anything extravagant, and there are some criteria that must be met.
For instance, the meals must be “ordinary and necessary,” and either you or an employee must be present at the meal. You must also provide the meal to current insurance customers, potential prospects or similar business contacts.
Fishman says there is no exact dollar limit in regards to what’s considered extravagant, so you’ll need to use your common sense here. He also says it’s crucial to maintain detailed records, including the date, how much you spent, including the tax and tip, the restaurant you ate at and the nature of the business relationship.
As long as you take careful note of everything, this can be a nice deduction, especially if you frequently take contacts out to eat.
One of the not so great parts of being self employed is self-employment tax, two federal payroll taxes that fund Social Security and Medicare. Everyone who works has to contribute, but employees only have to pay half, while their employer pays the other half.
If you’re self-employed, you are responsible for the entire amount. In 2019, self-employment tax was 7.65 percent for employees and 15.30 percent for people who are self-employed.
The good news is that the IRS considers the employer portion of self-employment tax to be tax deductible, writes Liz Smith at financial technology company SmartAsset. You can claim it on your tax return, which can provide some considerable financial relief.
Work-Related Education Expenses
Part of working as an independent agent is maintaining insurance licenses and certifications. And of course, this comes at a cost.
Fortunately, independent agents are often able to deduct these as work-related education expenses, which include tuition, books and lab fees. The IRS outlines the basic criteria for claiming these as deductions, saying an expense must be for education that helps you maintain or improve the skills needed in the insurance industry or that the education is required by law.
For the full rundown on work-related education expenses, consult this resource from the IRS.
In some cases, you may also be eligible for deductions on your health insurance premiums. As long as you meet the right criteria, you can deduct expenses paid for medical and dental premiums for yourself, your spouse and dependents who are under the age of 27, writes financial journalist Tina Orem at personal finance website NerdWallet.
This applies to fees from doctors, dentists, surgeons, psychologists, chiropractors and even nontraditional medical practitioners. For the full details, check out this guide from the IRS.
One Last Piece of Advice: Find a Good Accountant
Finally, it’s usually recommended that most independent agents hire an experienced accountant familiar with small businesses, sole proprietorships and the insurance industry. Trying to handle it yourself, especially if you have very limited experience, can lead to costly errors.
“If you run your own show, it’s important that you use the help of a professional,” says Rebekah Parr at New Horizons Insurance Marketing. “The saying goes that hiring a CPA (Certified Public Accountant) to do your taxes can pay for itself, because they find every possible deduction for you, not to mention making sure you have all your i’s and t’s dotted and crossed.”
Not only should this ensure that everything gets properly reported and prevent tax penalties, it will make your life easier and allow you to focus more on business growth.
Stay on Top of Taxes
There’s a lot that goes into becoming an independent agent, and taxes are certainly a big part of it. This is a major responsibility and one that can seem a little overwhelming, especially if you’ve been used to working for an employer in the past where the company handled your taxes for you.
But it’s definitely something that’s manageable. It’s just a matter of taking the time to understand the basics of taxes and knowing how to track expenses for deductions.
Images by: rostislavsedlacek/©123RF.com, stockbroker/©123RF.com, kantver/©123RF.com, kurhanx/©123RF.com
Talk to an expert