The United States is a nation of entrepreneurs. There are literally tens of millions of self-employed individuals that enjoy pursuing their dream business.
Of course, few enjoy the paperwork and confusing tax issues that arise from owning their own business.
Many self-employed individuals are considered “sole proprietors” or “independent contractors” for legal and tax purposes.
This is true regardless of whether they are turning a hobby into a business, selling a digital product online, or providing services.
As self-employed individuals, they report business revenue results on their personal income tax return.
Following are a few guidelines and issues you should keep in mind if you are one of those pursuing your entrepreneurial spirit.
Schedule C – Form 1040
As a self-employed person, you are required to report your business profits or losses on Schedule C of Form 1040.
The income earned through your business is taxable to you as an individual. This is the case even if you do not withdraw any money from the business.
While you are required to report your gross revenues, you are also allowed to deduct business expenses incurred in generating that revenue.
If your business efforts result in a loss, the loss will generally be deductible against your total income from all sources, subject to special rules relating to whether your business is considered a hobby and whether you have anything “at risk.”
Many self-employed individuals work from home and may be entitled to deduct a percentage of certain home costs that are applicable to the portion of the home that is used as an office.
This can include payments for utilities, telephone services, etc.
One may also be eligible to claim these deductions if she performs administrative tasks from home or store inventory there.
If working from home and also at an additional office at another location, one may be able to convert commuting expenses between the two locations into deductible transportation expenses.
Since most self-employed individuals find themselves working more than the traditional 40-hour week, there are a significant number of advantageous deductions that can be claimed.
Unfortunately, it’s more common than not that most self-employed individuals miss these deductions because they are unaware of them.
Self-Employment Taxes – The Bad News
A not-so-great aspect to being self-employed is the self-employment tax.
All salaried individuals are subject to automatic deductions from their paycheck including FICA.
Because many self-employed individuals often do not run a formal payroll for themselves, the government must recapture these taxes through the self-employment tax.
Simply put, you are required to pay self-employment taxes at a rate of 15.3% on your net earnings up to a certain amount.
In an interesting twist that reveals the confusing nature of the tax code, you are allowed a partial deduction for the self-employment tax. Simply put, you are allowed to deduct one-half of your self-employment taxes from your gross income.
If, for example, you pay $10,000 in self-employment taxes, you are allowed a deduction on your 1040 return of $5,000. Many self-employed individuals miss this deduction and pay more towards this tax than needed.
Health Insurance Deduction
Just because you’re self-employed doesn’t mean that you can simply take a health insurance deduction.
However, in the event that you do qualify, you’ll be allowed to deduct 100% of your health insurance premiums for you and your dependents.
No Withholding Tax
Unlike a salaried employee, self-employed persons are not subject to withholding tax.
While this at first sounds great, they are required to make quarterly estimated tax payments. If those payments are not submitted on time, a penalty could be given.
A potential and dangerous pitfall of being self-employed is failing to pay quarterly estimated taxes and then getting caught at the end of the year without sufficient funds to pay those taxes.
The IRS is not going to be happy if you fail to pay your taxes and you will suffer the consequences in the form of penalties and interest. Making sure you pay quarterly estimated taxes helps avoid this situation.
You must maintain complete records of all business income and expenses. Simply put, document everything.
Create a physical and/or digital filing system for each month, and file every receipt.
All business travel expenses must be documented, including auto mileage you incur when performing business tasks. An app works well to keep track of this.
If in doubt about documenting something, just do it!
Self-Employment Taxes Don’t Have To Be Frustrating
As a self-employed individual, your focus and time is spent on making your business successful.
Your focus is not on the complexities of the tax code and how to limit the amount of taxes you owe.
For support with dealing with your self-employment taxes, reach out to us on Facebook.