Whether you’re a freelancer, working on a contract or run your own business, you’re likely to be met with the same question by jealous friends when you tell them that you’re self-employed.
While it seems like an obvious distinction to make – either you work for someone or yourself – it’s important to understand the technical definition of what it means to be self-employed, especially come tax season.
The IRS has a lot of detailed information about the state of self-employment that you should consult before assuming you qualify, but here is a summary of the facts.
Am I self-employed?
There are three questions that you can ask to determine, generally, whether you are seen as self-employed in the eyes of the IRS.
Firstly, do you trade or operate a business as a sole proprietor or independent contractor?
Secondly, are you a part of a partnership that runs a business?
And lastly, are you in business for yourself, even if it is only part time?
If you can answer “yes” to any of these questions, you might be considered as self-employed.
Do I have to pay tax?
Simply put, yes.
Most self-employed professionals pay estimated tax every quarter, and file their annual tax return just like everybody else, but there are additional obligations that you need to know about.
Self-employment tax, often abbreviated to SE tax, calls for self-employed professionals to pay a tax that covers their Social Security and Medicare tax. This is a payment made in addition to normal income tax. It may seem unfair, but this additional cost is the same as the standard deductions made to those under the employer of a business.
Before you worry about that tax, though, you’ll need to work out your net profits and losses, as these dictate the severity of your tax obligations. It’s quite easy – subtract your expenses from your income.
If you’re operating at a loss, you can deduct that amount from your claim (although this is subject to restrictions and limits.)
If things are going well and you’re running in the black, you will be expected to factor your profit into your claim.
These rules are applied to anyone earning $400 or more from their self-employed business.
If you’re self-employed you won’t have a boss or company that’s withholding the taxes required from your salary each month, and that means you must pay SE tax.
Thankfully, there is a document that will help you work out exactly how much you should be contributing. Visit the IRS website and look for Form 1040-ES – you are going to need an annual tax return to fill in this document.
If it’s your first time filing a return of this nature, then you’ll need an accurate estimate of your income to calculate the estimated tax. Each quarter, you should be able to adjust your estimate until you get a more accurate idea of your business’ performance.
Filing your annual tax return is also straightforward. All you need is a Schedule C or Schedule C-EZ PDF document.
These documents allow you to declare your profit or losses. If your expenses are lower than $5,000 then you need the C-EZ document. This document will also guide you in calculating your Social Security and Medicare tax payments.
Structured for success
Even though you might be a business of one, you need to decide what type of company you are going to be operating as. This seems like a small decision but it will have major implications for your tax returns down the line.
Every type of business is required to file a different kind of tax return. Take the time to chat to an expert to make sure your business structure is suited to your needs from a tax perspective.
The home office – a tax dream
Most small business owners and self-employed professionals work from their home. It’s a little uncomfortable, but everyone starts somewhere – and the tax man will be kind.
Homeowners and tenants alike qualify for specific deductions related to rent, property maintenance, annual depreciation, and other costs. A self-employed tax calculator can help you figure out what you can deduct and how much you can write off.
Be sure to keep accurate records to make sure that you can verify your claim if need be.
Working as a married couple
It’s common for people to enter businesses in partnership with their spouses. If this is an option you’re considering you need to be aware of certain distinctions made for this kind of self-employment.
Although it’s crucial that you investigate all the implications of this type of working relationship, one important piece of information is the Small Business and Work Opportunity Tax Act of 2007.
This legislation essentially empowers married couples to be treated as individuals under Federal Tax legislation and not as a married couple. If you are a qualified joint venture, you may find that filing as individuals is more financially beneficial than applying jointly.
Tread carefully in this regard, as business and relationships tend not to mix well – especially when taxation is involved.
Getting more information
Before starting your business adventure, it is highly recommended that you visit the IRS Video Portal and go through the Small Business Taxes virtual workshop. These interactive lessons simplify and explain the ins and outs of tax as they apply to self-employed professionals, small business owners, and tax advisers.
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