No one likes doing them. But, the penalty for not doing them is pretty stiff. So, assuming you don’t want to develop an unhealthy relationship with the IRS, here’s what you need to do to get your taxes in order when you’re self-employed.
You Must Pay Tax On Everything You Earn
Self-Employment income can include everything you make for part-time work you do out of your home, or if you run a full-time business. This may include income you make in addition to a regular job. You must report all of this income when you file your taxes.
There are a few exceptions to this rule, however. For example, according to this Indianapolis law firm, who specializes in truck accident cases, you generally do not include winnings from a lawsuit in your income unless they include punitive damages.
Self-Employment Income Is Filed On Special Forms
You must file a Schedule C, Profit or Loss from Business, or a Schedule C-EZ, Net Profit From Business, with your Form 1040. You do this each year you earn income from your business. If you own a corporation, you must file other documents in addition to these tax returns.
Depending on whether you have employees, or you’re paying independent contractors, the paperwork may be a lot or a little.
Paying Self-Employment Tax
Self-employment tax is tax you pay for being self-employed. You generally must pay this tax in addition to your income tax because this additional tax is used to pay for Social Security and Medicare benefits when you’re older. You figure this tax using Schedule SE, Self-Employment Tax.
The amount of your tax is based on the amount of adjusted gross income you make, which is calculated from your Schedule C or C-EZ.
This is something a lot of business owners neglect to do. But, if you’re self-employed, you generally must make estimated tax payments. Business owners usually make them to pay taxes on income that’s not subject to withholding. If you don’t make estimated tax, you might have to pay a penalty when you file your income tax return. The underpayment of estimated tax penalty will apply when you do not pay enough taxes during the tax year.
States also impose this estimated tax rule on your business, though some states allow an exemption if you’re within a certain percentage of your actual tax owed. For example, if you underpay, but you’re within 90% of the tax you owe, the penalty is waived.
To adjust your gross income, the IRS allows you to deduct ordinary and regular business expenses. These are the costs incurred to run a business. You can deduct most business expenses in full. However, some costs have to be capitalized. This means you deduct only a portion of the expense each year, and you must itemize it over multiple years.
Ordinary and regular expenses are those necessary to start, and operate your business. So, for example, you may need electricity to keep the lights on, and heat to keep warm while you work. Both of these utilities are tax deductible. A personal cell phone, however, would not be a deductible expense.
Isabel Barry has been her own boss for several years now, and thinks it’s the best decision she ever made. She shares tips and advice for others who are just starting out in the world of self-employment.