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You can be the owner of a registered business, an e-commerce salesperson or a freelancer. In the eyes of the law, however, you are simply independent.
Filing taxes as a self-employed person is a little more complicated than filing one as a W-2 employee. You do not have an HR department to calculate the taxable figure for you. You also do not have a payroll team to deduct the correct amount from your payroll. Satisfying the IRS is your sole responsibility.
This Crazy Egg guide tells you everything you need to know about self-employment taxes, including why it’s important, how to calculate it correctly, and what you can do to save on tax money.
Why are self-taxes so important?
Self-employment taxes are the taxes that small business owners have to pay to the federal government to fund Medicare and Social Security. These are equivalent to FICA taxes paid by an employer.
Every U.S. citizen must pay taxes on their income. Since W-2 employees get their income tax withheld directly in their paychecks, they never really see the money coming into their account — it goes directly to the government.
On the other hand, when you are self-employed, it is likely that your income will not be taxed when you receive it. You may pay yourself in advance without withholding any amount, which means you will have to pay all the taxes of your income after receiving it.
What’s more, W-2 employees also have Social Security and Medicare taken out of their paychecks. Of course, you also need to help carry the burden by paying from your self-employed income, which is the part we call self-employment taxes.
If you do not report your self-employment tax and you earn more than $ 400 in profits during the year, you will find yourself on the wrong side of the law. Many things can happen, but none of them will be good.
Take e.g. Robert T. Brockmans sag.
On October 15, 2020, Brockman, CEO of a multi-billion dollar company, was charged in a 20-year scheme to hide $ 2 billion in revenue. With several serious charges against him, Brockman potentially risks a significant period of imprisonment, criminal forfeiture and compensation.
To put things in perspective, here’s what happens if you do not pay your self-employment tax:
The IRS prepares the tax return for you, without any tax benefits. You end up paying a lot more than you would have if you had filed the refund yourself. The IRS will impose heavy penalties on you, starting with 5% per month of the amount you owe, a maximum of 25% after five IRS can take your entire self-employment income to pay taxes back. Delay in filing tax returns can lower your future social security benefits. You may have trouble applying for personal or financial loans.
Therefore, be sure to submit your returns on time and avoid owing the IRS any money in the future. Set aside the necessary funds and start making estimated tax payments.
Quick Tips for Improving Self-Filing Files
Below, we’ve put together a list of tips you can use to make your life easier when filing self-employment taxes without getting on the wrong side of the IRS.
Keep track of the tax rate for self-employment
Currently, the self-employment tax rate is 15.3% -2.4% for Social Security and 2.9% for Medicare. Things are not so black and white though. The division of your self-taxation is for a reason.
The tax you pay on social security is limited based on your earnings, and the thresholds can change each year. For example, in 2020, the first $ 137,700 of a self-employed person’s salary, tips, and net earnings were subject to a 12.4% employment tax rate for Social Security. In 2021, this rose to $ 142,800.
On the other hand, the treatment for the 2.9% for Medicare is very different. First, there is no hood. Second, if your net income crosses the $ 200,000 mark (and you are single), you will have to pay an additional 0.8% for the Medicare portion, bringing your total Medicaid tax rate to 3.7%.
Track your business expenses carefully
When you are self-employed, you have a lot to do. Keeping track of all your business expenses takes back seat, making it harder to file accurate tax returns.
But you should definitely take the initiative to track all your expenses from the beginning of the fiscal year.
Unlike tax deductions, business expenses affect your net income. So when you lower your income, the amount you owe in tax is also reduced. For example, if you Buying new office furniture, you can get the amount you spent deducted from your income.
We strongly recommend using reliable accounting software to track your business expenses carefully. Eliminating manual labor to keep track of paper receipts not only saves time, but it will also make the entire cost tracking process less tedious.
QuickBooks, firstly, offers excellent accounting solutions to the self-employed. Sync it with your bank account and credit card to automatically track business transactions.
You can also take pictures of store receipts using the QuickBooks app, after which the software automatically matches them to your business expenses. Simple, safe and convenient.
Hire a good accountant
A common mistake most self-employed people make is to try to create their own accounts. It’s their attempt to save a few hundred dollars each year.
What they are not aware of is that an accountant does so much more than manage your finances.
Accountants can provide you with reliable tax advice, help you reduce your self-employment taxes, and help you file your self-employment taxes correctly.
The IRS has several rules and regulations for different scenarios, making self-employment taxes a little harder to follow for non-accounting experts. You will probably find yourself spending hours trying to get the calculations right if you are not talking accounting.
Plus, as an entrepreneur, your time is your greatest resource. Be sure to save it, and hire a good accountant to take care of your account and file tax returns.
Choose estimated quarterly tax payments
The IRS allows you to make quarterly tax payments if you expect to owe $ 1,000 or more in taxes when you file tax returns. You can either pay your total estimated tax bill on April 15 or split it into four equal amounts. If you choose the latter option, be aware of due dates, which are:
1st payment – 152 April – payment 173 June – payment 164 September – 15 January
Paying tax in small amounts will help keep your cash flow stable as opposed to paying a large amount at once.
Depending on your location, you may also owe estimated quarterly payments to your state office.
Although we have used the word “estimated”, you should make sure that the figures are as accurate as they can be to avoid deficits. Not paying enough in quarterly payments can result in you being penalized by the IRS.
Save 25% of your self-employed business income on tax payments
Dealing with tax liabilities is not easy.
You need to find out how much you actually earn after tax for each fiscal year. In addition, your final tax figures, including self-employment taxes, will always vary based on your net income, deductions, expenses, credits, registration status and several other factors.
Fortunately, things do not get so complicated if you follow a simple rule: set aside at least 25% of your earnings for tax purposes. That is it.
You can either take 25% of the amount each time you get paid by your client and put it in a separate account or do it monthly after calculating your total income. This way, you do not have to worry about having insufficient cash to pay your taxes.
Long-term strategies to reduce self-employment taxes
It can be difficult to pay the entire amount of self-tax owed. After all, that’s over 15% of your income. The good news is that you can reduce this amount legally.
Send your taxes to 1040
Any person earning $ 400 or more in self-employment income must file a tax return. The return must include a Schedule SE, which is a standard tax form used to calculate the tax due.
However, when you file your tax return using 1040, you can take advantage of a deduction — count your self-employed tax payments as an adjustment to your income.
Depending on how much self-employment income you earn, you can deduct between 50% and 57% of your self-employed tax payments. Having an accountant will definitely come in handy at this point.
Select an S-Corp option
LLC (Limited Liability Company) or business owners can reduce their self-employment tax burden by choosing to have their business taxed as an S Corporation or S-Corp.
With an S-Corp, you can pay yourself a reasonable salary out of earnings as well as distribute remaining profits to yourself or other shareholders or partners. You can also leave the money in the company if you want. In some situations, the money that exceeds your salary is subject to income tax, but not taxation.
For more context, an S-Corp owner only pays Social Security and Medicare taxes on their salaries, while LLC owners have to pay independent taxes of 100% of their share of the LLC’s profits.
That said, a choice for S-Corp may not be the best for your business. Talk to a tax or business formation professional before you switch.
Reduce the total net profit
Schedule C is required to calculate your net worth of self-employment. You must include this as income on your 1040 and in Schedule SE to calculate your self-employment taxation.
Your net income corresponds to the gross income you have earned minus your deductible business expenses. So the lower your net income, the lower your tax bill.
If you want to reduce your self-employment tax, be careful when preparing your Form C. Be sure to deduct all possible business expenses, including office rent, phone bill, office supplies, equipment, and acquisition and maintenance costs for commercial vehicles, among other expenses.
Remember that your business expenses must be ordinary and necessary to run your business in order to be deductible – they can not be personal.
Now that you have a good idea about your taxes, the next step is to make sure you take steps to keep track of your business expenses. This will help you make accurate tax estimates to make quarterly payments and take advantage of deductions to lower your total tax amount.
We strongly recommend getting an accounting software tool to get your finances in order. Another great tip is to set up a business account to separate your personal finances from your business finances.
Check out the following Crazy Egg guides to choose the best accounting software and company account for your business: