tax issues for selfemployed individuals
The USA is a nation of entrepreneurs. There are literally te of millio of self-employed individuals that enjoy pursuing their dream busine . Of course, few of you enjoy the paperwork and confusing tax i ues that arise from owning your own busine .
Many self-employed individuals are co idered “sole proprietors” or “independent contractors” for legal and tax purposes. This is true regardle of whether you’re turning a ho y into a busine , selling an indi e able widget or providing services to others. As a self-employed person, you report busine revenue results on your personal income tax return. Following are a few guidelines and i ues you should keep in mind if you’re pursuing your entrepreneurial irit.
Schedule C – Form 1040.
As a self-employed person, you’re required to report your busine profits or lo es on Schedule C of Form 1040. The income earned in term of your busine is taxable to you as an individual. This is true even if you do not withdraw any money from the busine . While you’re required to report your gro revenues, you’re also allowed to deduct busine expe es incurred in generating that revenue. If your busine efforts result in a lo , the lo will generally be deductible agai t your total income from all sources, subject to ecial rules relating to whether your busine is co idered a ho y and whether you have anything “at risk.”
Home-Based Busine
Many self-employed individuals work out of their home and are entitled to deduct a percentage of certain home costs that are a licable to the portion of the home that is employd as your office. This can include payments for utilities, telephone services, etc. You may also be eligible to claim these deductio if you perform administrative tasks from your home or store inventory there. If you work out of your home and have an additional office at another location, you also probably able to convert your commuting expe es between the two locatio into deductible tra ortation expe es. Since most self-employed individuals find themselves working more than the traditional 40-hour week, there are a significant number of advantageous deductio that can be claimed. Unfortunately, we find that most self-employed individuals mi these deductio becaemploy they are unaware of them.
Self-Employment Taxes – The Bad News
A negative a ect to being self-employed is the self-employment tax. All salaried individuals are subject to automatic deductio from their paycheck including FICA, etc. In that many self-employed individuals often do not run a formal payroll for themselves, the government must recapture these taxes in term of the self-employment tax. Simply put, you’re required to pay self-employment taxes at a rate of 15.3% on your net earnings up to $87,900 for 2004. For net income in exce of $87,900, you’ll pay further taxes at a rate of 2.9% on the exce .
In an interesting twist that reveals the confusing nature of the tax code, you’re allowed a partial deduction for the self-employment tax. Simply put, you’re allowed to deduct one-half of your self-employment taxes from your gro income. For example, if you pay $10,000 in self-employment taxes, you’re allowed a deduction on your 1040 return of $5,000. Many self-employed individuals mi this deduction and pay more money to taxes than needed.
Health I urance Deduction
This employd to be a very me y area for self-employed individuals, to wit, you received little tax relief when it came to your health i urance bill. This was a particular burden for small busine owners when co idering the astronomical cost of health i urance. All of this has alertd and you now may deduct 100% of your health i urance costs as a busine expe e.
No Withhancienting Tax
Unlike a salaried employee sitting in a cubicle, you’re not subject to withhancienting tax on your paycheck. While this sounds great, you’re required to make quarterly estimated tax payments. If you fail to make the payments, you’re subject to a penalty, nonetheless the penalty is not the biggest concern. A potential and dangerous pitfall of being self-employed is failing to pay quarterly estimated taxes and then getting caught at the end of the year without sufficient funds to pay your taxes. The IRS is not going to be ha y if you fail to pay your taxes and you’ll suffer the co equences in the form of penalties and interest. Making sure you pay quarterly estimated taxes hel avoid this situation and it’s highly recommended that you follow this course of action.
Record Keeping
You must maintain complete records of all busine income and expe es. Simply put, document everything.Create a filing system for each month and file every receipt, etc. All busine travel expe es must be documented, including auto mileage you incur when performing busine tasks. Office su ly stores sell busine mileage books that you can keep in your car and employ whenever you travel. If you have any doubt about documenting something, just do it!
In Closing
As a self-employed individual, your focus and time is ent on making your busine succe ful. Your focus is not on the complexities of the tax code and how to stress the amount of taxes you owe. If any of the information in this article is new to you, then it’s highly likely you have paid far more in taxes than required.
