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Not wanting the hassle of more complicated taxes is what keeps many from taking contract or freelance work, or starting a home business. However, while self-employment tax filing does require a few more steps, it can also mean greater tax savings.
Here is a basic primer about taxes for the self-employed.
NOTE: I’m not a tax expert. I encourage you to talk to a tax professional or refer to the IRS website for more information.
Glossary of Tax Terms
1099 – Form similar to the W-4, 1099-MISC provides information on self-employment earnings from rents, royalties, and contract work. If you earn more than $600 from a company (affiliate income, freelance or contract pay, etc), the company will send you a 1099 showing your earnings for the year. Note, even if you don’t earn $600 from a company, you still need to report earnings. For example, if you earn $300 from a company, you may not receive a 1099, but you still need to report the $300 as income on your taxes.
Deductions – You can deduct expenses related to your business, including supplies, equipment (depreciated if expensive), meals out, travel and more.
Depreciation – Used primarily on large expenses (i.e. technology equipment), depreciation involves the gradual deduction of the item over time.
Estimated Tax – As an employee, your employer deducts and sends taxes to the government every month. As a self-employed person, you have to send estimated taxes only four times a year, if you expect to owe $1,000 or more at tax time.
Hobby-loss rule – If you make money from your hobby, you can deduct expenses, with some limitations. If it’s just a hobby, you can only deduct up to the amount you’ve earned. In other words, you can’t have a loss. If you’re efforts are to build a business, to avoid being considered a hobby, you need to prove you’re trying to make a profit. Some things the IRS might look for in proving you have a business include having business license and business bank account, and marketing efforts. You can only take loss on a business 3 out of 5 years, before you’ll be considered a hobby.
Home Office Deduction – The IRS allows you to deduct the cost of doing business in your home. This is one of the perks of working for yourself, because many of the allowable expenses you can deduct are for things you’re paying for anyway, such as Internet and electricity. The requirements to take this deduction are that your home office is used regularly and exclusively as where you work. You can only take the deduction on the actual square footage of the home that you use. If you use half a bedroom, you can only deduct the square footage of half.
The IRS gives you two choices when taking this deduction: 1) Simplified in which you multiply $5 by the square footage of your office space, and 2) Regular which allows itemization of actual expenses. You can deduct costs such as utilities based on the percentage of your home that the home office takes up.
Self-Employment Tax – In a traditional work situation, your employer takes out and sends your Social Security and Medicare payments on your behalf. When you work for yourself, you have to pay this through your taxes. Currently, the self-employment tax rate is 15.3% percent on the first $127,200 of self-employment income you earn. You’re able to deduct half of this expense.
Schedule C (or Schedule C EZ) – This is the form you use on your taxes to report your business income and expenses.
Self-employed health insurance premiums – You’re allowed to deduct your health insurance premiums for coverage of yourself and family.
Simplified Employee Pension (SEP) – A SEP is a retirement plan option for the self-employed. Contributions are tax deductible .
Standard mileage rate – You can deduct actual business-related car expenses or use the Standard Mileage Rate to deduct car expenses. To take this deduction, you need to track your miles, tolls, and parking. There are apps to help with this, or you can simply keep a small notebook in your car.
W-9 – Similar to the W-2, the W-9 is the form companies ask that you fill out when you’re hired as a contractor. Many affiliate programs ask for this form as well. If you use a service to help you sell your goods (i.e. Amazon for publishing your book), you’ll need to supply a W-9.
Getting Organized for Tax Time
- Have a system for tracking your income and expenses. Software, such as Quicken Home and Business or QuickBooks, or online financial services, such as FreshBooks can help you with this. At tax time, you simply need to print out a report for your tax preparer or import the information into your tax software.
- Be sure to save receipts. Many financial software programs allow you to scan to import receipts into your program. Or you can use ShoeBoxed to manage your receipts. For paper items, create a filing system to organize business receipts. Also, don’t forget income and expense data from PayPal or other places you take or pay money online.
- Know what items you can deduct so you can be sure to track the expenses for them. Be sure to include your start up expenses.
- Use an app or notebook to log in your business mileage. Each time you drive the office store, visit a client, or travel for business write down the miles. You can use this notebook to track toll and parking expenses, as well.
- Mark estimated tax time on your calendar so you can pay it. If you end up owing $1,000 or more, you may have to pay penalties, so it’s worth the time to deal with estimated taxes.
With a simple system of tracking and keeping the data in digital form, filing self-employment tax doesn’t have to be complicated.
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