Tax Tips for the Self-employed
There are many benefits that come from being your own boss. If you work for yourself, as an independent contractor, or you carry on a trade or business as a sole proprietor, you are generally considered to be self-employed.
Here are six key points the IRS would like you to know about self-employment and self- employment taxes:
- Self-employment can include work in addition to your regular full-time business activities, such as part-time work you do at home or in addition to your regular job.
- If you are self-employed you generally have to pay self-employment tax as well as income tax. Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. Self-employment tax include both parts as the employer and the employee. You figure self-employment tax using a Form 1040 Schedule SE. Also, you can deduct the employer’s part of your self-employment tax in figuring your adjusted gross income.
- You file an IRS Schedule C, Profit or Loss from Business, or C-EZ, Net Profit from Business, with your Form 1040.
- If you are self-employed you may have to make estimated tax payments. This applies even if you also have a full-time or part-time job and your employer withholds taxes from your wages. Estimated tax is the method used to pay tax on income that is not subject to withholding. If you fail to make quarterly payments you may be penalized for underpayment at the end of the tax year.
- You can deduct the costs of running your business. These costs are known as business expenses. These are costs you do not have to capitalize or include in the cost of goods sold but can deduct in the current year.
- To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.
Self Employed Tax Return
The first step in filing a self-employment tax return is choosing the right form. What most people who work for themselves discover when filing their first return is the short 1040 forms (1040-A and 1040-EZ) fly right out the window because several new pieces of information must be reported.
Here are the forms you can expect to file if self-employed:
- Form 1040: The Form 1040 is required for individuals who are self-employed because it accounts for the self-employment tax.
- Schedule C: Schedule C allows you to report your income or loss from a business you operated or a profession you practiced as a sole proprietor. If you accrued expenses of $5,000 or less, you may be eligible for the Schedule C-EZ short form.
- Schedule SE: Schedule SE allows you to report your Social Security and Medicare taxes. The income or loss you calculated on Schedule C is used to calculate your self-employment taxes paid during the year.
Accounting for Self-Employment
As a self-employed, you don’t receive a Form W-2 (Wage and Tax Statement). Instead, you receive a 1099-MISC when you have earned more than $600 in income for nontraditional sources. The source of your income is required to send you the 1099-MISC so that you can accurately file your return on time. The deadline for sending out the form is Jan. 31, following the year you earned your income. Your source of income also submits a copy directly to the IRS.
Regardless of whether or not you receive the form, you are required to report all of your income from self-employment.
Keep in mind that in order to secure a deduction you need not only an expense that qualifies as deductible, you also need have adequate documentation to support the expense. That generally means proving the expenditure was incurred (typically with an invoice) and proving it was paid (canceled check, receipt, etc.).
Self-Employed Tax and Payroll Tax Cuts for 2012
Most self-employed workers must pay self-employed tax. To determine the tax amount, first calculate 92.35 percent of your net profit (or loss) from Schedule C. Then, you take 15.3 percent of that income as your tax.
So for example, if your net profit was $20,000 on Schedule C, you would multiply your earnings by 0.9235 to equal $18,470. Now, multiply $18,470 by 0.153 and $2,825.91 is the self-employment tax.
On your Form 1040, you are allowed to reduce your adjusted gross income (AGI) by deducting part of your self-employment tax. In your case, you simply divide it by two, for a deduction of $1412.95.
The good news for many self-employed workers is that a 2-percent payroll tax cut was approved that lowers your self-employment tax for 2012. So using the above example, you multiply $18,470 by 0.133 (0.062+0.042+0.0145X2) to owe $2,456.51 as your self-employed tax and $1,412.96 becomes your deduction.
Tax Deductions and Credits
Now that you have an idea what income you must report and taxes you’re likely to owe, let’s look at some ways you may be able to reduce your tax liability. Tax return deductions and credits both help you to owe fewer taxes, but they work differently. Tax deductions are write-offs that reduce your taxable income, while credits reduce your tax bill dollar for dollar. As a person who is self-employed, there are a few deductions to look out for:
- Deductible part of self-employment tax: As mentioned in the previous section, this deduction, which reduces your adjusted gross income (AGI), is typically one-half of your self-employment tax.
- Self-employed SEP, SIMPLE and qualified plans: This deduction accounts for self-employed workers who contributed to retirement plans in the tax year. It also reduces your AGI.
- Self-employed health insurance deduction: You may be able to deduct the amount paid for health insurance for yourself, your spouse and your dependents with this deduction.
Determining Your Estimated Tax
What’s unique about being self-employed is that the companies or individuals you work for don’t withhold your taxes since you’re not their employee. You have to consider the estimated tax, which is the amount you pay to the IRS quarterly to make up for not having your taxes withheld automatically by an employer. If you’re wondering whether you should have paid your quarterly estimated taxes for 2012, the IRS says you must pay if both of the following are true for you:
- You expected to owe at least $1,000 in taxes for 2011, after subtracting your withholding and refundable credits.
- You expected your withholding and refundable credits to be less than the smaller of:
- – 90 percent of the tax to be shown on your 2011 tax return, or
- – 100 percent of the tax shown on your 2010 tax return
If the above applies to you then you should have been paying your estimated tax on 2012 income, the amount of which can be determined by filling out an Estimated Tax Worksheet.
In order to pay your quarterly estimated tax, which is typically due June 15, September 15 and January 15 each year prior to filing your return on April 15, you can fill out Form 1040-ES (Estimated Tax for Individuals), or visit the Electronic Filing Tax Payment System (EFTPS) and pay your quarterly taxes online.
Assuming you have paid your quarterly estimated taxes, this amount is used similarly to federal withholding in that it reduces your total tax on page two of your Form 1040.
As you crunch numbers, you’ll find that taxes for self-employed workers can be pretty complicated. And, of course, when you throw property ownership, stock investments or other businesses into the equation, things get even more complex.
So, if you feel that filing under these circumstances is too overwhelming, don’t hesitate to ask for help.
