Unless you grew up helping your entrepreneurial parents with their tax filing or hang out with many tax professionals, you probably need to learn how to file self-employment taxes.
As a small business owner, you probably don’t have a human resources department to help you with withholdings. And most likely there’s no payroll team to deduct the right amount from your paychecks. That means the responsibility falls on your shoulders to satisfy the Internal Revenue Service (IRS).
It’s not easy, but following these simple steps can give you a chance to develop sound business practices. Those practices can help you manage your cash flow so you can make timely and accurate self-employed income tax payments.
Step 1: Understand your tax responsibility
If it seems like you pay more taxes on your self-employment earnings than you did as an employee — you’re right. This is because you are responsible for both income tax and self-employment tax.
Self-employment tax — what the IRS abbreviates as "SE tax" — covers Social Security tax and Medicare tax. As an employee, these taxes are split between yourself and your employer. For self-employed individuals, you pay it all.
So, how much is self-employment tax? It depends on how much you make. Here's what you may have to pay:
You pay this on 92.35% of your net earnings from self-employment. You do not have to claim self-employment income if your net earnings are less than $400.
Self-employed taxpayers pay 12.4% for Social Security and 2.9% for Medicare. The amount of your earnings subject to Social Security is capped every year, and that amount varies annually.
Additional medicare tax:
You pay an additional 0.9% if your total income, including self-employment and non-self-employment income, is over:
- $200,000 for a single person;
- $125,000 for a married person filing separately; or
- $250,000 for a married person filing jointly.
Self-employment taxes are included in your tax return and are not exhaustive of the overall tax you pay to the IRS. In addition, these are just federal taxes, and the total amount you pay depends on your self-employed tax deductions.
And this is just the IRS! You are also responsible for state taxes, licenses, fees, permits, and other charges levied by your region or municipality.
Step 2: Know what income you must claim
The IRS gives a simple explanation of how much you must claim.
First, self-employed individuals have to determine the amount of their net profit or loss by subtracting their business expenses from their business income.
If you have a profit of $400 or more, you must include that in your 1040 gross income.
If you have a net loss, you may deduct that loss. However, you can't deduct every loss or for an unlimited amount.
Step 3: Complete your return
At its most basic, here is how to file self-employment taxes step-by-step.
- Calculate your income and expenses. That is a list of the money you've made, less the amount you've spent. While you may have a 1099 form for some payments you've received as a contractor — a 1099 is like a W-2 — you may have to gather invoices for the rest.
- Determine if you have a net profit or loss.
- Fill out an information return. This is only required for certain types of payments or businesses. Visit the IRS website on information returns to see if it applies to you.
- Fill out a 1040 and other self-employment tax forms. These will include a Schedule C or Schedule C-EZ to report your income or loss. It will also include your Schedule SE (Form 1040), Self Employment Tax.
Since the paperwork can be lengthy and complicated, it’s helpful to have an accountant or certified public accountant (CPA) to help with tax preparation and review your documents before submission. (Bonus: getting an accountant’s help is deductible!)
Step 4: Pay on time!
Another thing that works a bit differently for self-employed individuals is when you pay your taxes. Most self-employed people have to make quarterly payments, estimating the amount they will owe throughout the year. See the IRS’s estimated tax payment schedule.
You can use IRS form 1040-ES to figure out your quarterly tax payments. The form also has vouchers you can use to remit the amount owing to the agency.
Step 5: Stay updated on self-employment taxes
Knowing the nuts and bolts of paying self-employment tax is one thing. Integrating that knowledge into the daily operations of your business can be quite different. Here are some useful tips to stay on top of your taxes:
Always pay your taxes in full and on time
While filing taxes quarterly is no party, it’s far better to feel the pain of taxes regularly than to put it off and end up with a huge bill from the IRS.
Ask for help
An accountant or financial advisor can help relieve the burden. If you need more confidence in how to file self-employment taxes, partner with a professional who can show you how.
Include taxes in your budget
Set aside the amount of taxes you'll have to pay so the money is available when the bill is due. Budget for 25-40% of your quarterly profit to be safe.
Keep all receipts from business-related expenses
The IRS lets you reduce self-employment tax by deducting expenses. Keep track of everything you spend throughout the year. Your receipts, mileage, and even vehicle depreciation can all be used for tax purposes.
Deductible expenditures include business insurance, health insurance premiums, vehicle, and use of your home if they are legitimately part of your self-employed expenses. These deductions can help you reduce your overall taxable income.
Minding the details of your business
Paying self-employment taxes likely means you've made a profit on your business. To keep that positive aspect going, remember to mind all of your operation's legal and administrative aspects.
That means paying taxes, keeping your license and certifications up-to-date, understanding your contractual obligations to partners and clients, and holding business insurance to keep you protected.
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