March 16, 2021
Category: Tax Advice
What Should Self-Employed People Know About Filing Taxes This Year?
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors.
There are plenty of perks when you’re self-employed. But when tax season rolls around, things can start to get tricky. Unlike traditional workers, self-employed workers usually have more tax responsibilities. On top of filing annual tax returns, typically, self-employed individuals pay the IRS directly four times a year in what are known as estimated quarterly taxes.
In this article, we’ll dive into a general overview of taxes if you are self-employed. We’ll also list a few tax deductions to consider, which can help cut down your tax bill.
When you work as an independent contractor, own a small business, or have a side hustle, you have to pay taxes on your net profit. Net profit is essentially your total revenue minus total expenses. As a self-employed worker, you’ll have to pay federal income tax, and, in some places, state and local income tax. You’ll be responsible for paying self-employment tax to the IRS.
If this all sounds overwhelming, we get it. Below, we’ll go over more in-depth about taxes for individuals who are self-employed.
When you work for yourself, you have to pay both income tax and self-employment tax. If you earn more than $400 in net earnings from your business, you have to file an annual income tax return on either From 1040 or 1040-SR, as you normally would if you were earning income as an employed worker for another company. As a self-employed worker, however, you will pay estimated taxes quarterly, rather than having taxes withheld from each paycheck like individuals employed by a company.
Self-employed workers also pay the IRS self-employment tax, which is a Social Security and Medicare tax made primarily for those who work for themselves. According to the IRS, this tax is very similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.1 The current self-employment tax rate is 15.3%.2 12.4% of the self-employment tax goes to Social Security, and the remaining 2.9% goes to Medicare.
As we mentioned earlier, self-employed workers file an annual tax return, but they also should make estimated quarterly tax payments to cover Federal income tax and self-employment tax since they don’t have a company withholding taxes from each paycheck. You can use Form 1040-ES to help you estimate your quarterly tax payment to the IRS. Once that’s done, you can pay your estimated quarterly payments online or through the mail. To pay online, use the Electronic Federal Tax Payment System. To mail in your payments, you can use the blank vouchers in Form 1040-ES.
Budgeting for taxes is a must to be a financially fit, self-employed individual. One way you can approach this is by estimating your total earnings for the year. For example (and ignoring for the moment that you may owe state and local taxes too), let’s say you are a freelancer. You have net profit or net earnings of $40,000 after accounting for expenses, and you estimate that you have to pay at least 25% of this to cover your income taxes and self-employment tax. That comes out to $10,000 for the year, and so your estimated tax payment to the IRS each quarter should be $2,500. By estimating how much you’ll earn and your tax rate, you can figure out how much money to save from your income to stay on top of your quarterly tax payments.
You might be able lower your tax bill by taking advantage of tax deductions that apply to self-employed workers. Most of these tax deductions are related to expenses or operating costs. Some of the essential deductions to consider include:
It helps to have a separate checking account to keep track of all your business expenses, and don’t forget to keep all the receipts of your business expenses. This is particularly useful to share with your tax professional or to itemize spending when you file your tax return.
Managing your tax obligations if your self-employed isn’t fun, but it can be done. By doing some early planning and estimations, you can get ahead of your estimated quarterly payments. If you don’t feel confident filing on your own, we highly recommend speaking with a tax professional to avoid any problems during tax season.
Fortunately, ACE Cash Express can help. Find a tax professional in your local area who can help you navigate the tax filing process.