The word alone is enough to send most self-employed individuals running for the hills. There seems to always be some form of confusion around how to pay your taxes, or what’s expected of you by the IRS, when you’re self-employed. It doesn’t help that the tax laws change with some regularity, throwing a wrench in how you file, or what you can expect.
Although every situation is unique, it never hurts to go over the basics to make sure you’re approaching your self-employed taxes correctly.
What’s Your Business Entity?
The first step in figuring out how to pay your business taxes correctly is to determine your business entity. If you’re not sure, you’re probably a sole proprietor. Sole proprietors are usually freelancers or solopreneurs who only have to worry about themselves in their business. You don’t have to fill out any paperwork with the IRS to be a sole proprietor.
The next level up is an LLC, or Limited Liability Company. LLCs do require that you apply for your LLC with the state where you do business. You’ll receive an EIN, and can open business bank accounts, and file your taxes on behalf of your business. An LLC can choose to be taxed as a sole proprietor, or as a Corporation.
A corporation (think: Inc. at the end of your business’s name), is a full-fledged incorporated business entity. Even as the business owner of a corporation, you’ll likely pay yourself as a W-2 employee.
So, what’s the difference?
A sole proprietor (or an LLC being taxed as a sole proprietor) files a Schedule C each year that records their income and business expenses. Because you’re only focusing on your taxes as a sole proprietor, you pay income taxes on whatever profit your business pulls in, and you pay your self-employment tax. A corporation or partnership (or LLC being taxed as a corporation) operates a little bit differently.
The profits your business pulls in likely still flow to you, the business owner, but not 100% of the time. You may have other employees, or be investing back into your business. So, corporations pay taxes on payroll and on their business profits. In short, you’re getting taxed as a salaried employee (even as the business owner), and the business is also paying taxes on any profit earned.
Know How You File
Generally, all business entities have to pay quarterly estimated tax payments to the IRS. Taxpayers, regardless of their business’s entity, do this through the government’s EFTPS system. To file your estimated quarterly tax payments, you’ll need to secure a Tax ID number (ITIN). Some self-employed individuals will have an EIN (Employer Identification Number). Then, you pay quarterly taxes either by check in the mail or electronically through the EFTPS system. To estimate your quarterly payments, you can use the IRS’s Form 1040-ES. If you don’t keep up with your estimated tax payments, you could get stuck with a penalty, which is currently 5% of the total repayment amount you were late submitting to the IRS.
Get a Grasp On Your Deductions
Knowing what’s deductible, and what’s not, is a game changer for the self-employed. Some things may seem obvious, like a new laptop that you purchased specifically for work purposes. However, some aren’t as predictable, and can be a major benefit come tax time! Some of these might be:
- Contributions to a Solo 401(k)
- Continuing education
- Automobile expenses
- Health insurance premiums
- Home office expenses
- Internet and phone
- Interest on loans
The list goes on and on. Make sure you’re taking advantage of all of these!
Keep Your Receipts
Even if you’re legitimately taking advantage of all of your available deductions as a business owner, you need to keep a record of all of these expenses. Holding onto receipts, or logging them in an accounting software can be a huge help should you ever get audited by the IRS. It will also come in handy when you file every year.
Remember The Self-Employment Tax
A lot of people have no problem estimating their quarterly state and federal taxes, but they forget one important thing – their self-employment tax! Self-employment tax rate is 15.3% for 2018. This tax includes 12.4% for Social Security, and 2.9% for Medicare. Typically, people who work a traditional 9-5 are paying into Social Security and Medicare with every paycheck. Because self-employed individuals aren’t paying into those programs with any regularity, this self-employment tax covers those contributions and makes sure that you’re “paid in” when you need to access those programs later in life.
Use the Right Tools
Using the right tools can make all the difference as someone who’s self-employed. Trying to DIY your taxes can be headache-inducing, and there are so many different types of technology or resources that you can leverage to make your life significantly easier. Here are a few things to look into:
Accounting software isn’t just for tracking your receipts. They also offer time tracking, invoicing, reporting, budgeting, CRM capabilities, and in some cases they estimate your quarterly tax payments for you. A solid accounting software can help you avoid slip-ups and stay organized when it comes time to file your taxes at the end of the year. Popular programs include QuickBooks, FreshBooks and Wave.
Outsourcing your accounting to a bookkeeper can free up a significant amount of time in your business and help to ensure that you’re ready at tax time. (I personally love having a bookkeeper – my reports are reconciled every month and they send out 1099s at tax time.)
A Financial Planner
A financial planner who works with business owners can help you to stay organized and set goals for both the business and the business owner. Whether you need help walking through how to maximize tax benefits as a business owner, if you should hire an employee to support your growing team, or how to start efficiently planning for retirement as a business owner – a financial planner can help. If you want to learn more or want to see if a financial planner would be a good fit for your current business needs, schedule your 15-minute introductory phone call by clicking here.