Best Way to File Taxes for the Self Employed
It’s common knowledge that self employed people must pay income tax like everyone else, but sometimes it can be tricky to know what exactly qualifies as self-employment. The taxpaying community also seems well aware of self employment tax, as well, but again the specifics get a little hazy. Today we’re going to clear the air and clarify how self employment taxation works and how you can best file your taxes if you’re self employed.
Who Classifies as Self Employed?
If you run a small business on your own as a sole proprietor, you’re clearly self employed. You also work for yourself if you operate as an independent contractor or are one of the partners in an official partnership. (If you get a Schedule K at the end of the year, you’re in a partnership.)
Keep in mind that you need not work your business full time in order for the IRS to tax you on self employment income. If you have a side gig selling crafts at local fairs, for example, you’re technically working for yourself. If you make more than $400 doing so during the year, the IRS expects you to report the income and pay tax on it.
What are My Self Employed Tax Obligations?
When you work for yourself, you take on two tax obligations. The first is making estimated tax payments throughout the year. The income tax is a pay-as-you-go tax, meaning that you pay taxes on your income as you earn it throughout the year. When you work for someone else, they deduct these taxes from your paycheck for you automatically and send them to the U.S. Treasury on your behalf. When you work for yourself, this becomes your responsibility.
Working for yourself also means paying self employment tax. The concept of this tax confuses many people. Here is what it really means. When you work for a typical employer, you and the employer share the burden of the FICA tax. The FICA tax is the tax that pays for Social Security and Medicare.
The FICA tax rate is 15.4 percent. Ordinarily, your employer withholds 7.65 percent from your pay and pays the other 7.65 percent themselves. Alas, when you work for yourself, you have to pay both halves. That is the self employment tax that people refer to. The good news is that you can deduct half of what you pay, so you’re ultimately not penalized or taxed at a higher rate for choosing self-employment, as some people erroneously believe.
How Do I Make My Quarterly Payments?
As we’ve mentioned, those who work for themselves must pay their income taxes throughout the year as they earn their income. This is tricky, however, because you may not know how much money you will really make if your work comes in at irregular times — which it often does for freelancers.
To solve this problem, the IRS offers a worksheet that will help you estimate your business income, your adjusted gross income, and the amount of tax you will owe on it. This amount is then broken down into four estimated tax payments, which you send to the address listed in the IRS instructions along with your form 1040-ES.
These estimated payments are due on the 15th of the month following the end of the quarter. Let’s say, for example, that you make estimated tax payments during 2022. Your first three payments are due April 15, 2022, July 15, 2022, and October 15, 2022. The final quarterly payment is due January 15, 2023. If the 15th falls on a weekend or holiday, your payment will be due the next business day.
Note that you need not make estimated tax payments if you expect to owe less than $1,000 in tax.
How Do I File My Annual Return?
When filing taxes self employed, don’t let the process throw you for a loop. You need to add a few more forms to your tax return, but you’re still doing the same thing you’ve always done: you’re just adding up your earnings and then taking any deductions you can.
You’ll start by gathering all of the forms and paperwork you need. The IRS forms you need will be the following:
- Form 1040
- Schedule C
- Schedule SE
- Schedule F (if you’re a farmer)
You will also need some forms and receipts of your own. You may not need all of these forms. You won’t have a Schedule K, for example, unless you’re part of a business partnership. You will need to gather some or all of the following, depending on your situation:
- Form 1099-MISC or 1099-NEC
- Schedule K
- Business income statement / records
- Receipts for business expenses
Once you have all the paperwork you need, the IRS instructions will guide you through where to report the numbers on your tax forms.
Send it all to a Professional
If you run a small business, you may find filing taxes self employed fairly easy. But there are some cases where a tax professional can come in handy. There is often, for example, confusion about when you can take the home office deduction and when you can’t. The rules for limited liability companies can also get a little complex. If thinking about it all gives you a headache, a professional CPA may be well worth the cost. She may also be able to reduce your tax liability by finding deductions you may have missed.
Married Couples Business – What is a Qualified Joint Venture?
Ordinarily, the IRS considers you a sole proprietor if you own and operate a business yourself. If you own and operate that business with someone else, the venture is a partnership. The rules change, however, if your business partner is also your spouse.
Previously, married couples running a business together had to either file the sometimes complicated paperwork of an official partnership or simply report the income under one spouse’s name. If they chose the latter option, only one spouse got credit for their earnings when it came time to apply for social security benefits.
To solve this problem, the IRS now allows husband and wife teams who operate a business together to split the income and expenses onto two separate Schedule C’s (or schedule F’s, if they farm.) In order to file under the qualified joint venture rules, the business must not be a C corporation or a limited liability company. It is further required that only the husband and wife be involved in the business venture and that both participate materially in the business. Both spouses must also agree that they don’t want to treat the venture as a partnership for tax purposes. You cannot file under the qualified joint venture rules if you file separately, either. Your filing status must be married filing joitly.
Don’t Forget Your State Income Taxes
When you think about your income taxes, the IRS instantly springs to mind. It’s important to remember, however, that your state may charge income tax too. And just like the IRS, your state may also require estimated tax payments.
Pennsylvania, for example, imposes a 3.07 percent income tax on both wages and money earned through self employment. Like the federal government, Pennsylvania expects estimated payments. In this case, the state requires the payments from anyone who expects to make $8,000 or more from a source that won’t automatically withhold taxes for them.
Every state has different requirements, and some don’t have an income tax at all. Wherever you live, remember to research your state’s rules regarding self employment and taxation along with the IRS rules. Failure to do so could result in expenive fees and penalties from the state even if you’re good with the IRS. This information is usually readily available through the state’s department of revenue, but a CPA can help you if you’re having trouble finding the information you need.
Plan for Next Year’s Self-Employment Taxes
Filing taxes self employed is the hardest the first year you’re in business. As the process and the forms you use become more familiar to you, things do get easier. One way to make sure that happens is to start planning for next year’s taxes as soon as this year’s are done.
While you have it handy, you can use information about your actual income from this year to help you make a better estimate of what you might expect to make next year. You should also get those estimated payment due dates on your calendar now while you’re thinking about taxes. Failing to make estimated taxes is one of the most common tax mistakes that self employed people make, along with underestimating what they may owe.
Whether you need help navigating self employment taxes for the first time or would like some guidance on planning for next year, remember that Picnic Tax is always here to help. Whether you just need a quick answer or need someone to take a stressful return off your hands, we’re happy to offer our assistance. From a pep talk when you’re running out of steam to full-fledged tax preparation and filing services, Picnic Tax has you covered whatever you need.