It is nerve-racking to make money through self-employment. However, making money can be even more stressful during the time when taxes are computed and collected out of your business income. To avoid the stressful impacts of tax collection, here are some important questions and answers for you to be fully aware of self employment tax.
WHO ARE CONSIDERED SELF-EMPLOYED?
Generally speaking, being self-employed has the following criteria:
- You act as a sole proprietor or an independent contractor of a certain trade or business.
- You belong to a partnership that operates a trade or business.
- You’re doing a part-time business.
WHAT ARE MY SELF-EMPLOYED TAX OBLIGATIONS?
Being self-employed requires you to file an annual tax return and to pay a quarterly estimated tax.
Those self-employed people generally should pay the so-called “self-employment tax” (SE tax) and income tax as well. What is SE tax? It is a form of Social Security and Medicare tax being collected from those who are self-employed. It’s the same with the Social Security and Medicare taxes being withheld by the employers from the wage earners. When the term “self-employment tax” is used, it certainly refers to the recently mentioned taxes, not to other taxes, for example income tax.
You have to figure out your business net profit or net loss before your self-employment tax and income tax is going to be determined. How to do this? It’s done by just subtracting your business expenditures from your business profit. The difference is a net profit which directly becomes part of your total income found on page 1 of Form 1040. It is applied if your expenses are less than your income. However, the difference is your net loss if your expenditures are more than your business income. You can then deduct your net loss from your gross income on page 1 of Form 1040. In some cases, the net loss is limited.
See Pub. 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ) for more details.
You should file an income tax return given that your self-employed net income is $400 or more. There’s a different situation if your net income is less than $400. In this case, however, you’re still required to file an income tax return only if you meet the requirements specified in the Form 1040 instructions .
HOW DO I MAKE MY QUARTERLY PAYMENTS?
Estimating the tax is a way being used to pay Social Security and Medicare taxes and income tax. It is done since you’re self-employed or you don’t have an employer withholding the said taxes for you. Form 1040-ES, or the Estimated Tax for Individuals (PDF)is used to determine these taxes. The same form has a worksheet that is the same with Form 1040. To fill out Form 1040-ES, you just need your annual tax return in the previous year. You have to use the worksheet in Form 1040-ES to estimate the tax for and such form is also used to determine if you’re required to file your estimated tax in a quarterly basis.
Form 1040-ES further has blank vouchers. You can use such vouchers when you forward and submit your estimated tax payments through mail. About the payment, you can as well do it by way of Electronic Federal Tax Payment System (EFTPS). If you’re in your first year as self-employed, the estimate of your expected income is needed. If you estimate a high income, you’re required to complete another Form 1040-ES worksheet. This is done to determine your estimated tax for the succeeding quarter. But if you estimate your income low, you’re then required to fill out another Form 1040-ES worksheet for the purpose of recalculating your estimated taxes for the following quarter.
HOW DO I FILE MY ANNUAL RETURN?
You need to use Schedule C or Schedule C-EZ to specify your income or loss being self-employed, either doing business or a particular profession. This is how you’re going to file your annual tax return. The Schedule C Instructions (PDF) helps you fill out the form.
Rather than Schedule C, people running small businesses and statutory employment with expenses of at least $5,000 or less can file Schedule C-EZ. You only have to read and understand the instructions in the Schedule C-EZ form in order to assess if you’re allowed to use Schedule C-EZ.
You should file Schedule SE (Form 1040), Self-Employment Tax for the purpose of reporting the required Social Security and Medicare taxes. Use the calculation of either income or loss on Schedule C or Schedule C-EZ to come up with your Social Security and Medicare taxes you should pay for that particular year. TheInstructions for Schedule SE can help you fill out such form.
AM I REQUIRED TO FILE AN INFORMATION RETURN?
It is a requirement for you to file an information return to the IRS once you’re making or receiving a payment from self-employment.
DO I NEED TO HAVE A FEDERAL EMPLOYER TAX ID NUMBER (FEIN) FOR MY HOME BUSINESS?
FEIN is not needed if you have no employees working for you or if you’re not planning to hire employees. In this case, you can use your social security number. However, it is important to note that you’re required to have a FEIN if you have Keogh Retirement Plan.
Any other form of business requires a FEIN. You could be required to have a FEIN if you want a bank financing. You’re also required if you’re interested to set up a bank business account. Having a FEIN is free and simple. All you have to do is to visit the IRS website.
BECAUSE I EARN SELF-EMPLOYED INCOME, SHOULD I HIRE AN ACCOUNTANT?
It is not a mandatory requirement. It is your option to seek for an outside help and counsel pertinent to you preparation for personal and business taxes. It’s good to seek for professional help if you don’t have any experience with preparation or if you’re just in your first year of being self-employed. It’s an important reminder that you can deduct the expense incurred for the preparation of your business taxes. This includes hiring a tax accountant.
You may also sign up to our tax planning education or coaching program to learn more.
HOW TO REDUCE TAX BILL?
There are many ways regarding tax deductions for self-employed like you. These ways can help you reduce your tax bill dramatically.
If a certain part of your home is used for your business, you have the opportunity to deduct the expenses incurred for that space being used as office in your home. Read our article on what and how to file for home office deduction for more details. The percentage of your square footage that serves as office space is used for the deduction computation.
You’re also entitled to have a tax deduction with respect to your utility bills which include your monthly heating and electricity bills as well as Internet bill. However, you have to consider that you most likely use your Internet for non-business transactions as well. We have an example here. A self-employed woman, named Sarah, deducts 50% of her monthly Internet bill as a business expense.
Office supplies such as paper, ink toner, postage, paperclips and others can be used to reduce the taxes. They are all deductible if those items are for business purpose. How about your new computer gadget or iPad? Your new gadgets can also be used for deduction. But if you only have one laptop or gadget, the consideration is that you’re going to use it also for personal purpose. In this case, a percentage is used for the deduction computation. How much the equipment is used for business (i.e. 50% or 60%) is the main parameter in this aspect.
HOME OFFICE UPGRADES
You’re thinking about buying a new desk, office chair, bookcase, desk lamp or other office furniture, aren’t you? You should understand that these things are all allowable deductions. There are two ways for a deduction claim: all at once in a year or gradually over the property longevity of existence, which is also known as depreciation deductions.
BUSINESS TRIPS AND TRAVEL
For business travels and conferences you need to attend, you can deduct the travel expenses from your tax payables. You can deduct the transportation expenses such as plane tickets, bus fare, taxis, airport parking, and car rental fees. You can also deduct your lodging and tip. During business days, you have the right to deduct 50% of your meals. You should take note that if you have an out-of-town business day, let say one on Friday and another one on Monday, you’re also entitled for tax deductions from your lodging and meal costs.
If your workplace is at home, it is obvious that you can’t deduct any kind of transportation expenses daily. However, you can deduct other forms of travel such as going out to meet a client, performing a job not at home, buying business supplies, doing research, or doing other activities related to your business. All of these deductible activities reflect to the standard mileage deduction (or public transit fares), parking and toll fees
If you’re self-employed, you can deduct the health insurance expenses for you or your family members. However, you’re not allowed to deduct your insurance for any given time once you can participate in the so-called “employer-subsidized plan.” An example of this is through your spouse or partner.
MEALS AND ENTERTAINMENT
Having a meeting with your client during lunch is a business tradition, but it also triggers confusion. Here are the things you need to know when deducting expenses for meals and entertainment. First, only 50% of the total bill for meals can be deducted, not the entire amount. What is more important for you to know is that the IRS is always looking at the excessive deductions due to extravagant food orders. You’ll be in trouble if you think you can go with your client to Barcelona via plane then you’ll spend about $300 bottle of Cabernet during lunchtime.
There’s one classic example how you can deduct your meal bills from your taxes. Lucy is a PR professional. She brought her new prospect or client to a place where they both had lunch. But the sole purpose of Lucy why she brought her client there is to finalize their contract. The bill of the meal was $74 including tips and taxes; then 50% out of it, she could deduct $37 for the basis of business expense. Then, she kept the food receipt and at the back of such receipt were the date and the client’s name being jotted down. There were also a few notes regarding their business discussion.
This guide is provided as a way for self-employed individuals like you to understand everything about self-employment tax deductions. To reiterate, it’s pretty cool to start doing your own business. But paying taxes is always a headache. This means you need to know everything about your rights and any requirements you need to comply.