So, you're thinking of becoming an entrepreneur. After years of working in an office, you've finally saved up enough capital to start your own business. You've even written a proper business plan to show that you're serious.
However, you also must consider one of the most important responsibilities of entrepreneurship: taxes. Filing your taxes becomes more complicated when you're self-employed.
Unlike regular employees, self-employed individuals are expected to keep track of their tax liabilities and pay them on time. You may find that your take-home pay has increased, but you should set aside a portion of your income to cover your taxes.
We will walk you through everything you need to know about filing a tax return as a self-employed person, plus tax deductions and exemptions to help you save money.
What it means to be self-employed
If you work for yourself, then you are self-employed. Many people think that self-employment only refers to side jobs or freelancing, but it also applies to people who have started their own businesses. In fact, most small business owners are also self-employed.
According to the Internal Revenue Service (IRS), an individual is considered self-employed if:
● They carry on a trade or business as a sole proprietor or an independent contractor
● They are a member of a business or trade partnership
● They are otherwise in business for themselves (including a part-time business)
Since the term applies to part-time ventures, you can also be both a full-time employee and self-employed. Just make sure to track your self-employed income so you'll be ready come tax time.
Self-employed tax obligations
The reporting threshold for self-employed individuals is $400. This means you are required to file a tax return if you earn more than this amount. Unless your business is structured as a C corporation, your earnings will be taxed at the individual rate.
You may also be required to pay estimated taxes quarterly if you expect to owe at least $1,000 in taxes when your return is filed. Underpayment of the estimated taxes may result in additional interest or fines.
Self-employment tax refers to the Social Security and Medicare contributions (also known as FICA) you're expected to pay as a self-employed individual.
For regular employees, the FICA taxes are split between them and their employer. However, self-employed individuals are required to shoulder the full 15.3% tax: 12.4% for Social Security and 2.9% for Medicare.
Self-employed tax forms
Use a Form 1040, U.S. Individual Income Tax Return, to file your annual taxes with the IRS. To calculate the tax due on earnings from self-employment, use a Schedule SE, Self-Employment Tax, and attach it to your Form 1040.
Use Form 1040-ES, Estimated Tax for Individuals, to calculate your estimated tax.
You may receive a Form 1099-MISC, Miscellaneous Income, from your business clients. Any income derived from self-employment, including those reported on a Form 1099-MISC, must be reported using a Schedule C attached to your tax return.
Self-employed tax deductions
Self-employed individuals can take advantage of tax deductions to help defray the costs of running a small business. Tax laws are constantly changing, and it's important to keep yourself updated to maximize your tax breaks. Here are a few ways to reduce your tax liability.
Self-employment tax deduction
The IRS allows entrepreneurs to deduct half of their FICA contributions from their income when calculating their taxes. The idea is the employer portion of the FICA taxes is considered a business expense, which makes it deductible.
Home office deduction
You can claim the home office deduction if you use a part of your home as your primary workspace. This allows you to claim a portion of your home expenses as a business expense.
For instance, if your home office occupies 10% of your home, 10% of your home utility bills, repair costs, and homeowners' insurance become tax-deductible. You can also deduct a portion of your phone and internet bills as a business expense. If you have a second phone line dedicated to your business, you can deduct the entire bill from your income.
To calculate your home office deduction, you will need to prepare a detailed floor plan of your home workspace (up to 300 square feet). This also comes in handy if the IRS conducts an audit.
Business rent deduction
If you rent a property for business use, you can deduct the amount you pay for rent from your taxable income. This deduction also applies to your home office. You can also deduct equipment rental fees and lease cancellation fees.
Health insurance deduction
Self-employed people who qualify for this program may deduct 100% of their health, dental, and long-term care insurance premiums. It's important to note that this is a special deduction for the self-employed, and your health insurance premiums are not considered as business expenses.
To qualify for this deduction, you must pay for your own health insurance premiums, and are not eligible to participate in a plan maintained by your employers or your spouse's employer.
Business insurance deduction
In most cases, you can deduct the premiums you pay for insurance related to your trade or business. This allows you to defray the cost of maintaining multiple insurance policies.
Deductible premiums include fire insurance, windstorm insurance, theft insurance, credit insurance, liability insurance, malpractice insurance, workers' compensation insurance, and business vehicle insurance.
Business travel deduction
If you regularly go on business trips, you may be able to deduct most of your travel expenses, including lodging, non-entertainment-related meals, dry cleaning and laundry, and the cost of transportation (e.g. airfare, taxis, car rentals).
To qualify for this deduction, the business trip should be away from your tax home or the general area where your main place of business is located. It should also take longer than one workday and require you to get sleep or rest.
How to file self-employed taxes
Filing taxes as a self-employed entrepreneur probably isn't at the top of your priority list, but it's important that you stay on top of your taxes. If you want to make sure your taxes are done correctly, your best option is to work with a professional tax service.
At TFX, we have been helping American entrepreneurs file accurate tax returns for over 25 years. Our tax experts can help you save time and money so you can focus on building and growing your business.