Managing your taxes as a freelancer, independent contractor, or small business owner can be quite a challenge. When you are your own boss, you need to be extra careful while dealing with the IRS to ensure everything is in order. As a self-employed individual, you must pay what the IRS calls self-employment tax (or SE tax). It can be intimidating to calculate and file these taxes, especially if you’re a first-timer. So, if you want to learn how to file self-employment taxes, stick around as we discuss the topic in detail.
What are self-employment taxes?
If you work for yourself, then you are obliged to pay the SE tax on your income. The self-employment tax is similar to the Medicare and Social Security Taxes that would have been deducted by your employer if you were working for someone else. According to the IRS, you are required to file SE taxes if you run your business as a sole proprietor, freelancer or independent contractor. Even if you are doing business on a part-time basis, you will need to file the SE tax.
In general, as a self-employed individual, you will pay more tax than wage earners. This is because you are solely responsible for your Medicare and Social Security taxes while salaried employees share the burden with their employers.
How do you determine your tax obligation?
The first step in accurately filing your SE tax is to calculate your net profit and loss. You can do this by subtracting your business expenses from your business income. If your expenses are less than your income, the difference between the two is your taxable income. You can find more details about this process in IRS Form 1040 Schedule C.
If you earn more than $400 in a calendar year through your business, you must file SE tax. You should also maintain a thorough record of all your business transactions, which might be verified during an audit.
Here is a general formula to calculate your SE tax:
- Step 1: Sum up all your earnings from self-employment. It should include any work done in a part-time capacity as well.
- Step 2: Apply the current self-employment tax rate (15.3% for the current year, 12.4% for Social Security, and 2.9% for Medicare) to your net profit.
You can deduct any employer-equivalent portion of your SE tax and calculate your revised taxable income.
Filing requirements and deadlines
As a self-employed taxpayer, you pay your taxes slightly differently than a salaried employee. Here are the key points you should understand:
Estimated tax payments
As an employer does not withhold your taxes, you must make these payments throughout the year, including your SE and income tax.
You must pay the IRS quarterly for your estimated taxes. Just fill out Form 1040-ES and submit it to the IRS on or before April 15, June 15, September 15, and January 15.
Annual returns
At the end of the fiscal year, you must fill out an annual tax return that includes your SE and income taxes. Here is how you can go about doing it:
- You need to use Schedule C to list gross receipts, calculate the cost of goods sold, and deduct business expenses. It will determine whether you incurred a loss or made a profit in the fiscal year.
- Using the net profit from Schedule C, you will complete Schedule SE to calculate the self-employment taxes you owe to the IRS.
You must file your annual returns before April 15 each year. If you need some more time, you can request an extension from the IRS.
Tips for reducing your liability of self-employment taxes
Now that you know how to file self-employment taxes, let’s talk about some strategies that might save you money on your SE tax.
- Business expenses: All business-related expenses are deductible from your SE tax liability. If you plan to use this strategy, ensure that you keep a meticulous record of all the expenses.
- Retirement plans: Setting up retirement plans like a SEP IRA or Solo 401(k) can significantly reduce your taxable income.
- Health insurance premiums: You can deduct the premium you pay for your health insurance from your taxable income.
- Home office deduction: If you primarily use a part of your home to carry out business-related activities, you might be eligible for a home office deduction.
Managing all these details can be overwhelming, especially when working alone. You can streamline the process by using various tools and resources. Services like TurboTax and H&R Block provide special self-employed editions of their software that you can use.
The IRS website also has some valuable information you can review to gain more clarity on the whole process. You can also use software solutions like QuickBooks and Mint to track all your expenses and income in one place, making filing SE tax easy.
While it might sound quite a hassle, filing SE tax is not that complicated, provided you have the right information and knowledge. Keeping good records, following the procedure, and being informed are the keys to tax compliance.