Tackling taxes when you're self employed
Welcome to the entrepreneurial economy, now employing about 15 million Americans, or 10 percent of the workforce. While being your own boss lets you opt out of a crushing commute, chatty colleagues, and unproductive meetings, taxes are still something you can’t escape.
The self-employed have a different set of considerations than most workers. Whether you’re running a small business with employees or working as an independent contractor, here’s a rundown of the tax issues you’re likely to face.
What kind of self-employed filer are you? Self-employment income falls into two broad categories: You either earn it from a business you own, or you’re an independent contractor working for someone else.
You can identify as a sole proprietor even if you have a full-time job and operate a side business. You’ll use your own Social Security number as your business’s tax identification number and, in most cases, file with a Schedule C or Schedule C-EZ to accompany your 1040 . The shorter Schedule C-EZ can be used if you had a profit, have no employees, and don’t claim the home-office deduction.
Incorporated businesses can save on taxes by paying out a portion of income in the form of a dividend (which has a lower tax rate than ordinary income). Dividends are not taxed if they’re considered a payout to a shareholder — in this case, you. While most dividends are paid in cash, you can also opt for a payout in the form of stock or other assets.
Probably the most dreaded of taxes is the self-employment tax because it doubles what self-employed people pay for Social Security and Medicare. When you are an employee, you and your company split the 15.3 percent total (12.4 percent for Social Security and 2.9 percent for Medicare), but self-employed people must pay both.
Luckily, you can get some of this back when you fill out your personal 1040 tax form. Half of the amount you pay in self-employment tax can be claimed as an income tax deduction. That means that if you pay $10,000 in self-employment tax, your personal taxable income will be lowered by $5,000. Since it’s filed on the 1040 and not on the Schedule C, it has no impact on your net earnings or the amount of Social Security tax you pay.
Some people erroneously believe that claiming the home-office deduction automatically tags them for an audit. In reality, it is no more of a red flag than any other deduction.
In order for you to claim the deduction, your home office must be your primary workspace, it must be used exclusively for work, and you must regularly meet with clients there.
To calculate the amount of the deduction, the IRS has instituted a simplified method: Deduct $5 per square foot, up to 300 feet, or $1,500 total. There is no need to calculate the proportion of rent, mortgage, utilities and Internet costs devoted to a home office — though it can be beneficial for you to do it that way, since there will be no $1,500 cap.
When it comes to saving for retirement, the self-employed sometimes have more options than wage earners. Depending on the plan, you might be able to subtract your contribution from your adjusted gross income on your 1040 giving you tax-deferred savings and an immediate tax deduction.
In addition to traditional and Roth IRAs, these are the most common types of retirement plans available to the self-employed:
If you have fewer than 100 employees, you can invest up to $12,500 (or $15,500 if you are over the age of 50). Simple IRAs allow you to contribute more than ordinary IRAs.
The Simplified Employee Pension IRA has higher contribution limits — up to $53,000 or 25 percent of your profit, whichever is less (if you are unincorporated, you may only put in 20 percent).
Like other 401(k) plans, the solo version lets you contribute up to $18,000 (plus an additional $6,000 if you’re over 50 years old). In addition to that, you can also put in 20 percent of your compensation, for a total of $53,000 (or $59,000 if you’re 50 or older).
Now that you know the tax tips that’ll help you get started as a self-employed person, consult a tax professional who can give you more guidance so that you can get back to doing what you love.