Being self-employed has its own pros and cons. Though you have the privilege to be your own boss you have to take on some extra responsibilities on your shoulders, especially in the matter of taxes.
Check out below to know more about self-employed individual tax:
Who is a self-employed individual?
A person is said to be self-employed if he/she fulfills any of the following points:
- He/she is the sole proprietor or an independent contractor of a trade or business.
- He/she is a partner of a business or trade.
- He/she is doing a business for himself/herself (this includes a part-time business also).
Tax obligations as self-employed
You are required to make “quarterly estimated tax payments to the IRS” and file a tax return annually. If you fail to pay taxes, you may get penalized. Self-employed individuals need to pay self-employment tax (it includes Social Security and Medicare tax for individuals working for themselves, also known as the “SECA tax”) and income tax as well.
How to prepare for quarterly self-employment taxes
You must take the $1,000 test before paying your taxes:
- Pay quarterly taxes if you owe more than $1,000
- Pay year-end taxes if you owe less than $1,000
What happens if you overpay or underpay quarterly taxes:
- When overpaid - Get a refund at the end of the year.
- When underpaid - Pay the unpaid amount at the end of the year with penalties (generally 6% to 8%) and interests.
Types of IRS tax forms required
- 1099-MISC: Fill a 1099-MISC form if you work as an independent contractor or when a company pays you more than $600 during the tax year.
- Schedule C or C-EZ: Include a Schedule C form with your personal income tax return to report income or loss of your business. Schedule C-EZ is a simplified version of Schedule C, which you can use if you have only one type of business and don’t have over $5,000 in business expenses.
- 1040-ES: You’ll need this form to file your estimated quarterly taxes.
- Schedule SE: This helps to calculate the amount of taxes you owe when you’re self-employed. However, you’ve to pay the full 15% as self-employment tax if you’re self-employed.
- 1040: You require this form to report your income and deductions to calculate how much income tax you owe.
Tips to file taxes if you are self-employed
Here’s a list of tips to help you file taxes easily when you’re self-employed:
- Set aside money for taxes - When you’re doing a business you must keep aside money to pay for your taxes.
Save at least 30% for taxes if this is your first year in business.
- Calculate how much you need to pay - You need to pay 15.3% as self-employment tax on your profit. So, talk to your accountant and calculate your profit and loss carefully to determine the amount you have to pay.
- Pay taxes online - Set up an electronic payment account to make online payments to the IRS. To do that, you’ll need to register for a PIN. The process may take a few weeks, so you must register before the due date of the payment.
- Pay on time - Keep yourself free from penalties and interests by paying taxes on time. Do you need to file an extension? If so, then do it by the deadline.
- Pay state taxes - Generally, people forget to pay their quarterly state taxes as well. Are you one of them? Yes? Never do that. Check with your accountant how much state tax you need to pay since state income tax varies from state-to-state.
- Trust your accountant - You may be able to cut back some of your business expenses and retirement contributions. So, trust your accountant in these matters to make the most of your money.
How to avoid self-employment tax penalties
Check out the ways to save money on tax penalties:
1. Make at least last year’s payment
Though you make quarterly tax payments, the final tax calculation is done at the end of the year. One way to avoid a tax penalty is to pay the same amount quarterly that you did last year and pay the remaining amount at the end of the year.
For instance, if you’ve paid $4,000 in taxes last year, consider paying this amount in 4 equal payments of $1,000 quarterly this year. If you calculate your taxes to be $5,000, pay the remaining $1,500 at the end of the year without paying a penalty.
2. Hire an accountant
If you’re a newcomer, then you must take help from a friend who’s self-employed or hire a CPA (Certified Public Accountant) to handle your taxes on your behalf. This way, you won’t remain behind your taxes and can save money as well.
3. Use a separate checking account or credit card
If you use a common checking account or credit card for both your business and personal use, it’ll be difficult for you to separate personal and business expenses and income while filing taxes. So, you must maintain a separate credit card and checking account for business so that there is no mistake when you’re filing taxes.
4. Keep a regular check of your income
If you track your income on a regular basis (say monthly or quarterly), you won’t have a problem while filing a tax return.
5. Use the IRS’s 1040ES worksheet
Calculating how much you owe to the IRS (especially when your income changes) can be difficult if you’re filing a tax return on your own.
Hence, you must use the IRS’s 1040ES worksheet on the IRS website to help you calculate your expected tax liability and check the deductions you may claim.
6. Keep aside extra money
If you underpay your taxes in the first quarter, you have to pay more the next time. Don’t worry, as you’ll get the money you overpaid as a tax refund at the end of the year after filing your annual tax return. So, you must overestimate payments if you have underpaid your taxes.
7. Keep the IRS tax helpline handy
Avoid paying penalties and clear your doubts about filing taxes with the help of IRS’s free helpline - 800-829-1040.
Tax deductions for self-employed individuals
Besides obtaining the same tax deductions as the employed taxpayers, you’re entitled to get additional deductions if you’re self-employed.
1. Deduct Business expenses
You can deduct ordinary and necessary business expenses to reduce taxable income irrespective of the type of work you do.
If you’re self-employed, you can deduct expenses like - office rent and utilities, inventory, equipment and tools, car and travel expenses, supplies, compensation paid to employees and contractors, insurance premiums, interest payments on loans or credit cards, and other costs incurred by your business.
2. Pay less self-employment tax
You must pay the self-employment taxes if your net profit is $400 or more on your Schedule C form. However, you can deduct one-half of the self-employment tax as an adjustment to your income.
3. Home office deduction
You can deduct the home office expenses for a workplace that you’re using exclusively and regularly for your business purposes (it doesn’t matter whether you own or rent it).
It includes mortgage interest, home depreciation, property taxes, homeowners insurance, utilities and home maintenance.
4. Retirement contributions and health insurance premiums
When you’re self-employed you can deduct taxes on health insurance premiums and retirement contributions to tax-deferred accounts like SEP-IRAs, SIMPLE IRAs and solo 401(k).
Over to you - Do you have any queries? Feel free to leave a comment in the box below.