Many people want to start a home business, but are held back by a crippling fear…of taxes.
While an envelope from the IRS can chill your bones, it’s definitely not the scariest thing about self-employment. It takes a lot of confidence, planning and determination to start a business from home. If you can channel those same skills into your taxes, you’ve got nothing to fear.
What are my Self-Employment Tax obligations?
Self-employed individuals are obligated to file the standard annual tax return as well as make estimated payments four times during the year. You are considered self-employed by the IRS if you are a sole proprietor, independent contractor or in a partnership.
On your return, you will be required to file income tax and self-employment tax (SE tax). The self-employment tax rate is 15.3%, of your net income and covers social security and medicare taxes. Essentially, the SE tax covers the payments your employer would have withheld from your paycheck.
What forms will I need for my annual returns?
Self-employed individuals will file a Form 1040 for their annual income tax return. You’ve likely used this form every year you’ve reported employment (whether you were self-employed or not), so this shouldn’t be new to you.
However, the 1040 only reflects income taxes, and you need to pay self-employment taxes as well. You’ll file a Schedule SE to account for your SE taxes (both social security and medicare).
Additionally, you’ll attach a Schedule C form to report profits and losses from your at-home business. This form is especially important if you plan to take any expense-based deductions.
Finally, you may need to file a Form 1099 or Information return if you made or received payment as a small business or independent contractor.
What about my business structure?
When you start your business, you’ll need to decide on a legal structure as this will affect how your taxable income flows through to your personal return.
Those who work at home typically start out as sole proprietors or independent contractors. As a one-person business, you probably won’t have to register with your state in order to exist (varies). You form a sole proprietorship simply by conducting business yourself. This can actually simplify your record-keeping and tax-paying.
However, you do have the option to incorporate as a different entity, such as an LLC or an S-corp. But don’t sweat over this too much—you can always convert your business structure later on.
Whatever structure you choose, it’s a good idea to secure a tax ID number for business purposes. Applying for an Employer Identification Number (EIN) is free and it helps keep personal and business records straight. Plus, you can give it to customers who require a W-9 and if you add employees later on, a tax ID is required.
How do I handle quarterly payments?
Because you don’t have an employer withholding taxes every paycheck, self-employed individuals are expected to make estimated tax payments every quarter.
As a general rule, self-employed individuals will make quarterly payments if they expect to owe at least $1000 in taxes. To calculate how much you will owe, use Form 1040-ES, Estimated tax for individuals. This form shows your income estimate and projects your tax liability. If you’ve been in business longer than a year, you can use your most recent annual return to estimate payment amounts.
Quarterly payments are made in April, June, September and the following January. You can mail in payments, but it’s easier to just set up an electronic payment account ( EFTPS). Once you’ve registered for your account (fair warning: processing can take a few weeks, so plan ahead), you’ll make quarterly payments online.
If you over- or underestimate earnings, you can submit another Form 1040-ES to refigure your estimated taxes. Then, attach a Form 2210 with your annual return to explain the payment discrepancies.
As long as you make smart calculations and set money aside regularly, quarterly payments aren’t so bad. Just mark tax deadlines in your calendar, so you don’t incur any late penalties.
Are there any deductions for being self-employed?
Yes! Filing self-employment taxes isn’t all headache. In fact, aside from being your own boss, some of the best perks of self-employment are the tax deductions.
Everyone is entitled to deductions, so don’t shy away from claiming them for fear of an audit. Of course, you can’t write-off everything—but any deductions you take reduce your taxable income, putting more money in your pocket.
If you want to claim credits or deductions, you have to have proof. Hang on to relevant documentation and stay organized. Keeping an eye on your books and producing regular expense reports will simplify this process for you.
Pro tip: When you do start working from home, create a separate account (even just a new line of credit with your current bank) for your business. This will make it much easier to keep track of what you’re making and what you’re spending on your business.
Here are a few great write-offs for self-employed individuals:
- Home Office: Any space that is used exclusively and principally for business can be deducted. Choose the standard option of $5 per square foot or calculate expenses in proportion to your home (including utilities, mortgage, etc).
- Mileage: Deduct mileage cost from vehicles used solely for business. Again, you can calculate actual costs or take the standard $0.545 per mile.
- State licensure fees: The amount you pay each year to your state or local governments for business licenses is fully deductible. (Sometimes initial licensing fees are not).
- Supplies and materials: Any business materials or supplies can be written off.
- Professional fees: Costs of hiring a lawyer, an accountant, or even a tax professional are deductible (including any startup fees).
- Pass-through businesses: The recent Tax Cuts and Jobs Act allows pass-through organizations (most small businesses) to deduct up to 20% of your business income.
If you’ve got the documentation to prove it, take every deduction you can. Be organized, proactive and strategic, and you’ll come to love tax time, not dread it.
How can I simplify tax processes?
It’s easy to breakdown expenses and win at taxes with the right software.
Cloud-based accounting programs are the norm today and they are incredibly secure and easy to use—plus, some of them are free! These software products can be accessed any time of day, from any platform and sync seamlessly with your bank transactions. Integrate your bookkeeping with other applications like reputation management and expense tracking tools to get the most out of your software.
Lots of tax software products make it dead simple to file self-employment taxes, without hiring a CPA. From free online services to desktop packages, these filing programs will walk you through the whole process—just follow the prompts and you won’t miss a thing. If you do get stuck, these companies generally offer tax support via phone or chat as well.
Should I hire a tax professional to help?
When you start your at-home business, you’ll be wearing a lot of hats and it’s okay to outsource if you can afford it. It does cost a little extra to have a bookkeeper or CPA on your team, but it can make a big difference—year round—to have that insight.
Even if you do hire a tax professional, you will save a lot of money by tackling the basic bookkeeping yourself. Your accountant will still expect you to track expenses and have accurate records, so don’t relinquish responsibility entirely.
If you’ve got enough gumption to start your own business, odds are, you’ve got what it takes to file your taxes as well. Just know that there’s no shame in hiring a professional if the budget allows.
You can conquer your fear!
If taxes really are the only thing holding you back from starting your own business, it’s time to conquer your fear.
Make taxes a priority, not an afterthought. Set aside money each month and mark payment dates in your calendar. Track expenses and take deductions—remember, you’re entitled to them! And when the IRS notices come in the mail, don’t ignore them. No dark-suited man is going to come knocking down your door, but there are penalties for neglecting your taxes.
Self-employment taxes are daunting, but planning ahead and knowing the facts will prepare you to come off conqueror.
About the Author
Jaren Nichols is Chief Operating Officer at ZipBooks, free accounting software for small businesses. Jaren was previously a Product Manager at Google and holds an MBA from Harvard Business School.