Filing Taxes When Self Employed
Filing Taxes When Self Employed – 4 Important Tips
Have you ever wanted to be your own boss and run your own business? I think most of us have at some point in our lives. Many years ago I started my own business and quickly learned that filing taxes when self employed, is a lot different than working for W-2 wages.
It’s different in several ways, but probably the one way that sticks out, is that you pay more in taxes. (We’ll cover this point more a little later.) I also discovered early on that you need to be disciplined and willing to work as long as it takes to get the job done. Working for yourself is not a 9 to 5 scenario.
That being said, we can now discuss the tax ramifications of a self employed worker. Basically, there are four areas we’ll cover in filing taxes when self employed. As a self employed business owner, you won’t have an employer withholding the various taxes that you are required to pay.
1. Make sure that you have a need to pay taxes
This first issue is self explanatory. If you’re not making any money, there probably is no tax to pay. The IRS says that if you have total self employment income for any tax year of at least $400, you must file a tax return.
What they’re essentially saying is that the $400 is subject to self employment tax. You may have other income that requires you to file a return and the $400 is reported on a Schedule C, business income form.
Something else to point out is that as a self employed business owner, you can’t pay yourself a salary on a W-2. You pay self employment tax and income taxes on the net profit of that business.
Starting out in the first year of your business, you need to set up a good system of financial record keeping. This is a key item for any new business. Keep accurate records of all income and expenses.
When you operate a new business, there are various deductions that can be used to reduce the income received. Knowing what you are able to deduct or not deduct, can become a little complicated for some. If you do your own taxes online, maybe not.
Engaging the services of a tax professional to file your tax return can be very expensive. The average fee charged using itemized deductions and then a Schedule C for your business operation is $450 and up.
2. Gather your tax forms & business records
Whether you use a tax professional or are doing your own taxes online, it’s imperative that all income be reported to the IRS. Working as a sole proprietor, you’ll more than likely receive a few 1099-NEC forms for services you provided.
That form is sent when you receive $600 or more in payments. However, there may be other payments that you received that didn’t total $600 from any single payer. The IRS requires that you report that income as well on your business schedule.
This is why we highly recommend that you maintain accurate records for your business. Don’t just report as income the total of the 1099 forms sent to you. You may get away with it for a few years, but if your return is pulled for any type of audit, the first thing the IRS does is to check for unreported income.
There are a number of different types of expenses that a self employed business owner may be able to deduct. The IRS says that if the expense is necessary and ordinary for your type of business, it may be deductible.
If you use your auto for your business, be sure to keep a mileage log detailing each time it’s used for the business. The same goes for your home office if it’s used for the business and you elect to use the regular expense method. You can also elect to use the simplified method by deducting the square feet, up to 300 square feet, times $5. As long as your office qualifies, no receipts are required for this method.
This differs quite a bit from a regular W-2 employee. They no longer can deduct any expenses they incur with their job, whereas a self employed freelancer can. Due to the Covid pandemic, many employees were assigned to working from their homes. Even though many incurred additional job expenses, they can’t deduct them nor can they use the home office deduction.
3. If I’m filing taxes when self employed, what taxes do I have to pay?
To begin with, the net profit from your Schedule C is subject to self employment taxes. What this means is you pay the entire 15.3% for social security and Medicare taxes. If you were a W-2 employee, you would have 7.65% withheld and your employer would also pay 7.65%.
However, when you factor in the actual computation, you do get a small break. The formula on the Schedule SE breaks it down this way. Net profit from Schedule C X .9235 X 15.3. So, the effective rate is approximately 14.13% of net earnings.
Besides the self employment tax, the net Schedule C income is subject to federal and state income taxes. Filing taxes when self employed isn’t that hard to understand. Because of the extra tax, some self employed business owners take their taxes to a professional and pay the high fees.
One of the most important things a self employed filer needs to do is to pay in the correct amount of estimated taxes each quarter. A calculation needs to be made for the self employment tax and federal and state income taxes, and then sent in to the IRS and state. If this is not done, you will be assessed penalties and interest.
4. Calculate and pay estimated taxes each quarter
At our firm, we send an email reminder to our clients a couple of weeks before estimated taxes are due. If this is not done, some individuals will use that cash for other expenses. Then at the end of the year when their tax return is filed, they won’t have the funds to pay their taxes.
It’s very important to keep all taxes paid and current as you go through the year. Filing taxes when self employed requires proper planning to make your quarterly estimated payments when due. It’s not hard to learn, but when tax time rolls around, you’ll know how to file your own taxes and save more money.