The first year of independent work went well. He managed to build a customer base, work hard and earn some money. However, April is just around the corner, and now is the time to pay the piper, or the tax collector where appropriate.
Everyone who works on their own must pay the IRS a percentage of their gross annual income. You should make sure you have some money in your bank account when the tax season arrives. Spending all your earnings without reserving them for the tax collector can chase you again during the filing season.
As a freelancer, you are responsible for submitting your return and paying your tax. Employees have the benefit that employers deduct taxes for their wages, but you must administer this process when it works for you.
We collect this short guide to give you everything you need to know when filing your tax return this year.
What entity are you using?
Autonomous taxpayers require a legal structure to define how they operate in the economy. People can choose to register their business formally by incorporating a company, or they can present themselves as a sole proprietor.
If you structure your business as a sole proprietorship, a partnership, an LLC or an S or C corporation, it will affect your tax return. We are going to unpack the tax requirements for each of these entities.
- Unique prop – As a sole proprietor, you must report your income and expenses on a form in Annex C. In this case, you are also responsible for paying the Social Security and Medicare costs.
- Corporations and Alliances – If you manage your business with a partner, you will present it as a partnership or a corporation. Associations must submit a statement of information, but generally do not have to pay any federal income tax.
Information returns are documents, such as Form W-2, that require taxpayers and businesses to submit and report and conduct business transactions with the IRS. You will use Form K-1 to report the actions of an individual in society and the income of an S-corps to the federal government authorities.
Unlike a sole proprietorship or company, a C-corp is recognized as a separate tax in the federal tax code. As a result, the corporation can claim special deductions on taxable income. This legislation also means that the IRS also taxes the entity at the corporate tax level. However, the income is taxed again in the tax returns of the recipient if they are distributed as dividends to the shareholders of the company.
S-corp taxes are similar to a company, since income is also transferred to personal tax returns. However, they are also like C-corps because they set salaries and withhold corporate payroll tax for homeowners.
One of the key advantages of owning an S-corp is that you can set your salary, subject to following the reasonable guidelines of the federal government. If the IRS determines that you are paying drastically to avoid paying taxes, there could be serious repercussions.
While an LLC is recognized as a legal business entity, it is a statewide designation and is not recognized in federal tax purposes. Therefore, an LLC must be presented as a corporation, sole proprietorship or partnership.
Read: TaxSlayer Review: Easily submit your tax returns online
Self-employment tax explained
Employers withhold FICA taxes on wages on payday. These Social Security and Medicare taxes are mandatory, and employers must pay the government on behalf of the employee.
Self-employment taxes cover Social Security and Medicare costs for self-employed people. Without an employer to do this for you, you will have to take care of these taxes yourself. If you have an income greater than $ 400 per year, the law requires you to calculate your self-employment taxes. You must submit Annex SE, which is attached to your individual 1040 tax form.
The tax rate for autonomous persons
As of the third quarter of 2019, the current self-employment tax rate stands at 15.3 percent. The rate has two components consisting of 12.4 percent for Social Security and 2.9 percent for Medicare. The Medicare component of the self-employment tax rate has no limit to the amount due from your net income from self-employment.
However, there is a limit on the Social Security component of the tax, known as the "Social Security salary base", and this rate changes every year, depending on economic and labor conditions.
For the fiscal year of 2019, the Social Security salary base is $ 132,000, a total of $ 4,500 from a base of $ 128,400 in 2018. Employees get the benefit of the employer that withholds half of these salary costs. These costs represent 1.45 percent of your annual salary for Medicare and another 6.2 percent for Social Security.
As a self-employed taxpayer, you must pay the full amount to the government for your Social Security and Medicare benefits. However, all hope is not lost, since it can deduct half of the self-employment tax as an income adjustment on Line 27 of Annex C.
In addition to a 2.9 percent tax on Medicare, those who earn more also pay additional Medicare taxes of 0.9 percent, on any income earned above the thresholds below.
- Married and filing jointly – $ 250,000
- Married and filing separately – $ 125,000
- Individual – $ 200,000
- Heads of household – $ 200,000
- Qualified Widow – $ 200,000
How you can pay the self-employment tax
At this point, you have an understanding of the basic concepts related to self-employment tax. However, it is time to learn how to pay those taxes to the IRS and the government. The self-employment and federal tax is similar in that they operate as a "pay-as-you-go" system for settlements.
It is for this reason that employers withhold their tax portion of their paycheck. Can you imagine if you had to write to the IRS a big, fat and juicy check at the end of the year with your Christmas bonus and a tax return?
Self-employed people are also more likely to have to make estimated quarterly payments if they start owing taxes above $ 1,000. IRS Form 1040-ES allows you to calculate your estimated self-employment taxes on page 6 of the document. There is also a section to include deductions for half of your self-employment taxes.
Use Form 1040-ES to calculate the estimated income tax and your self-employment tax obligations for the year. After obtaining this figure, divide it into four equal quarterly payments on the specified dates of April 15, June 15, September 15 and January 15.
These dates will pass to the next business day, in case the 15 falls on the weekend or a holiday. Make your estimated quarterly payments using an online system such as IRS Direct Pay, or by sending a personal check with vouchers included in Form 1040-ES.
When submitting your return at the end of the year, you must reconcile the totals. Use the estimated payment amounts you made against the amount of the self-employment tax and the taxes you owe. If you overpay, you can choose to reduce the amount of tax obligations next year or receive a refund by direct deposit into your bank account.
On the other hand, if you pay less, there will be penalty charges in addition to the outstanding amount due.
Read: Sage 50cloud Accounting Review: Complete Guide
What happens to late tax returns?
If the taxpayer owes at least $ 1,000 in self-employment and income for the year and does not make estimated quarterly payments, then the Internal Revenue Service evaluates them for a fine for paying the estimated tax when paying a tax return.
The IRS will calculate fines for underpayment by initially calculating the correct quarterly fees responsible for payment by the taxpayer. Then they multiply the outstanding difference by the interest rate established in that quarter.
The IRS then calculates that the fine is for each quarterly fee and charges fines for a quarter, but not all others.
Tips to reduce your self-employment tax
If you are an independent person, you can take the opportunity to reduce your total tax bill by using deductions. The IRS realizes that business expenses cost you money and that you are already paying taxes on most of these expenses when you pay them with the provider. Therefore, the IRS allows you to make specific deductions related to business expenses.
You can offset these costs from your gross annual income and pay a lower tax bill in the filing season. When requesting tax deductions, you have the opportunity to choose the standard deduction option or the detailed deduction option.
The standard deduction is a rate set by the IRS that they consider fair, ordinary and necessary for the daily operations and commercialization of your business. The detailed option allows you to deepen your expenses and make claims for costs that would not otherwise qualify using the standard deduction system.
With the detailed deduction system, you can claim the return of a variety of business expenses, such as the following;
- Home Office – You get a percentage of your rental or mortgage costs as a deduction if you work from home.
- Marketing – Costs associated with advertising, website maintenance and marketing budgets.
- Car expenses – You can cancel gas and mileage as long as you can prove that the trip was for commercial purposes.
- Subscriptions and memberships – Any cost related to industry subscriptions is a valid deduction.
- Operating costs – Any costs related to doing business on the site of its operations.
- Trip – Airline and train tickets, hotel accommodation, are valid expenses.
- Food and entertainment – Eliminate 50 percent of your business-related meals and entertainment-related expenses.
- Communications – Write down your internet and cell phone costs.
It is also important to verify your tax category before accumulating your deductions. If you have enough deductions, you could place it in a lower tax category, saving you more money.
Read: Commercial expenses: tax deductions and filing your returns
How to make use of tax deductions for gasoline and mileage
As a self-employed person, you can claim the return of travel costs related to the fuel and oil that you put into your car, along with the service costs, tire replacement and wear of your vehicle. However, to qualify for a deduction on your gas and mileage, you must keep accurate records of how you use your vehicle.
The IRS requires that you keep a record of your mileage, along with an explanation of each trip you take. You will have to differentiate yourself from the personal and commercial use of your vehicle, and you can only claim the return of miles related to the business.
When claiming the return of gas and mileage, you have two options. The standard option gives you a general number that you can add as a deduction to your statement. The actual option allows you to claim detailed expenses throughout the year. However, with the detailed option, you still have to count all costs.
If your expenses are high, you can expect an IRS audit. It is better that you have all your receipts if you decide to audit it. Even so, with the detailed deductions, you can deduct the depreciation costs of your vehicle, as well as the costs of leasing the company's vehicles.
In conclusion: hire an accountant
As a new taxpayer or self-employed worker, it is difficult to collect your tax return and make sure of all available deductions. However, with time, persistence and much learning, you will discover how to present your statement successfully.
However, we recommend that you avoid using the do-it-yourself approach when submitting your statement. The time you waste trying to discover how to compile your statement is costing you money. You could be making productive use of your time, instead of solving what the IRS wants from your business this year.
In addition, there is a good chance that you do not know the thresholds for detailed deduction audits. If you accidentally exceed the limits, you can expect an audit that could cause problems if your reports are inaccurate.
We recommend that you work with a qualified and experienced accountant when submitting your return. These professionals know what they are doing. All they need from you is your expense receipts. Let the professionals do the job correctly and they will end up returning you more on your tax return than if you had to do it yourself.
Disclaimer: The opinions expressed here are only those of the author, not those of any bank or credit card issuer and have not been reviewed, approved or endorsed by any of these entities.
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