Filing taxes is pretty straightforward when you work for someone else, but it's more complicated when you're self-employed. You have to set aside money for taxes on your own, keep records of your business transactions, and figure out which tax breaks you qualify for.
It can seem difficult, but with careful planning, you can make tax season much easier. Here are three steps every self-employed person should take throughout the year to prepare themselves for tax season, and to avoid penalties levied by the Internal Revenue Service (IRS) or even an audit.
1. Keep careful records of all income and expenditures
Forgetting to report income or misreporting your income is a surefire way to trigger an audit by the IRS.
If you earn more than $600 as an independent contractor in a tax year, the company you performed work for must send you a 1099 Form that lists how much it paid you during the year. Even if you didn't earn enough to receive a 1099, you're still supposed to list every penny you earned on your tax return. You should have your own records of how much money you made, so you can compare your numbers against your 1099s to ensure everything is accurate, and that you're not accidentally leaving things out and double check everything, twice!
You should also keep records of all business-related expenditures, like business travel, home office expenses, and office supplies. You can write these off on your taxes, but only if you have proof of the amounts you paid. Keep a folder with your receipts, utility bills if you're claiming a home office, and credit card statements listing your business expenses, and hold on to them for at least three years after you file your taxes in case the government decides to audit you.
2. Take all the deductions you qualify for
So you can write off business-related expenses when you're self-employed. If you're using tax-filing software, it should ask you questions to determine which credits and deductions you qualify for.
Remember, you can only write off expenses that are primarily for business use. You can't write off your cell phone bill just because you took a business call on it once.
You can write off health insurance costs and half of what you paid in Social Security and Medicare tax. When you work for an employer, these taxes are split evenly between you and your employer, but when you're self-employed, you must pay the full amount yourself. Together, Social Security and Medicare taxes cost you 15.3% of your income. However, you can use half of this as a tax deduction, which reduces what you owe in income tax. Depending on how much you earned throughout the year and the deductions you qualify for, you could even move into a lower income tax bracket so you ultimately lose a smaller percentage of your earnings in tax, as a result of taking this deduction.
3. Don't miss quarterly deadlines for estimated tax payments
Self-employed people usually pay estimated taxes quarterly. It's not a legal requirement, but at the end of the year, if you owe $1,000 or more in taxes, or you've paid in less than 90% of the taxes you owe, the government may charge you a penalty.
After your first year of reporting self-employment income, your tax return should include the minimum amount you need to pay in quarterly installments based on your income from the previous year. As long as you pay at least this much, you will avoid the penalty, even if you earn substantially more this year and end up owing more than $1,000 or 10% of your taxes at year's end.
For 2019, you must pay quarterly estimated tax payments by the following deadlines:
- April 15, 2019
- June 17, 2019
- Sept. 16, 2019
- Jan. 15, 2020
Typically, deadlines fall on the 15th of April, June, September, and January of the next year, however if one of these dates falls on a weekend, the deadline is extended until the next business day.
Use the estimates provided by the government to determine how much of your income you need to set aside each week or each month to cover your quarterly tax payments. You may want to keep this money in a separate savings account so you don't accidentally spend it. If you don't know how much you should pay in quarterly taxes, or you suspect that your earnings this year will be significantly different from the previous year, find an estimate using a Form 1040-ES.
If you run into any questions about filing taxes while self-employed, don't guess at what to do. The wrong answer could bring the IRS to your door. You may need to consult an accountant who can give you advice tailored to your situation, or do some more research on your own.