When you're self-employed, your tax situation is more complicated than someone who receives regular wages. The bad news is that you don't have an employer who takes care of paying the Internal Revenue Service (IRS) for you, so you have to stay on top of your taxes year-round. The good news is that you have more options to save on taxes than are available to people who earn a traditional salary.
To make sure you're fully complying with the tax rules and taking advantage of all the tax breaks you can claim, check out these five tax tips for self-employed folks.
1. Keep up with paying quarterly estimated tax payments
Workers who are classified as employees have money withheld from their paychecks for federal and state taxes, as well as for Social Security and Medicare taxes. As a self-employed person, no one withholds anything -- but you're still responsible for paying taxes as you earn money.
If you don't pay taxes throughout the year, you could face a hefty penalty when Tax Day rolls around. To avoid this unpleasant surprise, you need to make your quarterly estimated tax payments in April, June, September, and January. These payments are usually due on the 15th of the month, or the next business day if the 15th falls on a weekend or holiday.
Estimated taxes must be paid if you think you'll owe $1,000 in taxes or more, or if your tax liability was greater than $0 in the prior year. The Form 1040-ES, Estimated Tax for Individuals can help you figure out if you have to pay estimated tax as an individual.
If you're running your business as a corporation, you have to pay quarterly estimated tax if you expect to owe at least $500 in taxes. Form 1120-W, Estimated Tax for Corporations can help corporations figure out if they need to make estimated payments during the year.
You can avoid penalties by paying at least 90% of the current year's amount due, or, by using last year's taxes as a safe harbor number. If you pay in 100% of the taxes you paid in the prior year (or 110% if you have a higher income), you won't be penalized by the IRS.
2. Claim all the business deductions you're entitled to
When you work for yourself, you can claim many different tax deductions for business expenses. Depending on your situation, you may be able to deduct:
- Half the FICA (federal payroll) taxes you pay.
- Health insurance premiums paid for yourself or your family.
- The costs of legal assistance or assistance from tax professionals.
- The costs of entertaining clients.
- Your home office, if you have a dedicated office space in your house.
- Your vehicle, if used for business purposes.
- Interest on business debt.
Starting in tax year 2018, some businesses can claim a 20% deduction for pass-through income, which includes income from sole proprietorships, partnerships, LLCs, S-corporations, and rental properties. There are very complicated rules for whether you can claim this deduction, but it could save you a substantial amount of money if you're eligible.
3. Understand how your business structure affects your tax liability
When you're self-employed, you choose what type of business entity you operate as. Many people opt to run their business as a sole proprietorship or a partnership because it's easy and requires less paperwork. But another option is operating as an S-corporation. Choosing to incorporate your business provides liability protection, and it can also give you more flexibility when it comes to your taxes.
For example, if you operate as an S-corp, you can pay yourself a reasonable salary, and take some profits out of your company in the form of distributions -- which you don't pay FICA tax on.
Make sure you understand all of the different business structures, and be sure to account for all the tax rules, liability protections, and pre-requisites when choosing the best type of entity for your business.
4. Take advantage of tax breaks for retirement
Self-employed people don't have an employer to provide a 401(k) plan -- but if you're your own boss, you can open a retirement account for yourself. Many of these accounts allow you to claim a substantial amount of tax deductions for contributions to retirement savings accounts.
Retirement account options for self-employed individuals include:
- A SEP-IRA:As an employer or a self-employed individual, you can contribute up to 25% of net earnings from self-employed income to a SEP-IRA, with a maximum contribution of $56,000 for 2019. You have to account for SEP contributions and self-employment tax when calculating your income to determine your contribution limit.
- A SIMPLE IRA: As an employee, you can contribute up to $13,000 to a SIMPLE IRA in 2019. If you're over 50, you can make catch-up contributions of an additional $3,000. Employers also must contribute, and they are allowed to match employee contributions up to 3% of the employee's compensation.
- A Solo 401(k): As an employee or self-employed individual, you can contribute up to 100% of compensation or earned income with a maximum contribution of $19,000 in 2019 in a Solo 401(k). If you're 50 or over, you can make an additional $6,000 catch-up contribution. Employers can also contribute up to 25% of compensation, but self-employed individuals again must calculate income for purposes of determining contribution limits by subtracting contributions and self-employment taxes.
You can learn more about these retirement account options in this guide to five retirement savings solutions for the self-employed. You also have the option to contribute to traditional or Roth IRAs, but the aforementioned accounts are designed specfically for the self-employed and allow you to set aside much more money tax-free.
5. Get tax help if you need it
There's plenty to know about tax rules for the self-employed. Most individuals who earn a traditional salary can do their taxes on their own easily -- but if you earn income from a business, it may behoove you to get paid advice from a professional.
Certified public accountants (CPAs) and tax lawyers are usually the best resources for figuring out the most tax-efficient type of business entity to choose, or for trying to determine what deductions your business is allowed to take.
Stay on top of tax issues
As soon as you start earning income from a source other than a salary, you need to learn the IRS rules for self-employed workers -- even if you just have a part-time side gig. Take the time to understand the special tax laws applicable to you so you can maximize your savings, avoid penalties, and minimize what you and your company must pay to the IRS.
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